How to Buy a Company

Don’t buy a company until you’ve done your due diligence

You have an incredible opportunity to buy a business. Maybe you’ve known the owner for years or have even worked for him since you finished school. A partner may have brought this incredible opportunity to you and there is no down side. You might even have the cash, investors, or all the credit you need to make the acquisition. You know the business inside and out, or do you? Chances are that if you know how the business works but you have not been actively involved in all of the company’s financial and legal affairs, there are a lot of things you need to know before you spend a single dime. You need to know all of the fundamentals before you wire any money or sign a single check. You could get badly burned. You don’t know what you don’t know.

You need to do due diligence before you buy or acquire a company

Do your due diligence. But what is it? Before we get into any definition of due diligence or exactly what doing due diligence entails, we must warn you that the information we are providing herein is informational only and is not intended to protect you from any liability or pitfalls involved in buying or acquiring a business.

Due diligence is complicated and difficult, and even the most expert accountants and attorneys have made very big mistakes in the process. So, with this caveat, let’s talk briefly about what due diligence is and how it is done.

What exactly is due diligence? Please define due diligence for me

In a perfect world, and in the most simple terms, due diligence is gathering all of the information you need about a company, studying it, then interviewing all of the shareholders, directors, executives and key employees, gathering follow up information, studying it, asking more questions, and doing a lot of financial analysis along the way. You even need to do market research which will include an analysis of the competition as well as the projected demand for the services and products your acquisition target provides. When you are finished you should know everything about the company, including where it is today, its history, and where it is headed in the future. Ideally you’ll know all of the risks.

In the end, the ultimate goal is to discover exactly what the company you are thinking about purchasing is worth. In other words, given all of the potential and all of the risk, how much risk is it reasonable for you to take? In some cases, the answer may be that there is so much risk involved that you can only pay a little up front because you want the ultimate purchase price to be contingent of the company’s future revenue (you want a portion or a substantial part of your investment to be tied to earn-out payments).

How do you ask for due diligence and what exactly is included?

When you ask for due diligence, you usually start by signing a non-disclosure agreement with the prospective seller. This assures that both buyer and seller keep their negotiations confidential to the extent it is required to protect the parties. For example, sometimes the last thing a seller wants his employees to know is that he is thinking of buying a company. The buyer might not want other buyers to know the seller is contemplating a sale. He does not want to end up in a bidding war where no one wins. Once confidentiality is in place, then the buyer will provide the seller with a list of all of the documents he wants to see, which will include everything from tax returns, bank statements, trial balances, audited financial statements, customer and customer lists and contracts, key employee resumes, business plans, trademarks, copyrights, patents, licenses, litigation, insurance coverage, equipment lists, real property owned or leased, key contracts including consulting agreements, capitalization tables, the list goes on and on.