Importance of Due Diligence When You Have a Business Deal

Due diligence is an important step in any business deal. You need to review a prospect’s financial ability, navigate the complex legal process, and survey the market to ensure you don’t run into any surprises.

Due diligence also helps you arrive at the most appropriate price structure and find a way to secure a favourable transaction. Given the high stakes involved in any business deal, buyers should do their due diligence, otherwise, they could increase their risk of losses.

What is Included in Due Diligence?

Most due diligence reports are broken down into five key categories:

Legal Aspect: This step requires the buyer to understand all the liabilities of a business since they will be held liable for any contingencies, restrictions, and obligations. This step could be complicated, depending on the size of the business. Legal teams will have to look into current partnerships and contracts to ensure there are no complications before moving forward.

Financial Aspect: Business deals typically involve large transactions (often in excess of six figures or more). This means that conducting a financial check is of the utmost importance. More importantly, all documentation should be accurate and up to date before the deal is closed.

Sustainability Aspect: Long-term viability of the business and cash flow are important aspects of the due diligence process. Careful analysis of the sales data can help buyers dig deep into trends and decide if the investment is worth their while.

Interview with the Owner: A key aspect of due diligence when acquiring a business is to seek an interview with the former owner. This will provide a holistic review of the business, and the true intentions of the owner, and detail both positive and negative points that allow one to take the best course of action. It is also important to ask about the owner’s future projections, including quarterly and annual projections, as well as the assumptions used to make those projections.

Tax Aspect: Includes a review of the company’s tax returns and the overall tax structure. It focuses on income and non-income tax areas, including sales, payroll, property, and tax items. Underreported tax liabilities, payroll tax errors, and overstated operating losses are common risks for parties.

The Recommended Approach to Due Diligence

To ensure you fully understand the value of any business transaction, we recommend following this guide:

• Understand the reason for conducting the transaction
• Learn as much information as you can
• Request weekly updates about the business (or more)
• Be aware of any deal issues or open items with the business deal

Wrapping Up

Due diligence is important and should not be skipped before any transaction, particularly complex business deals involving large monetary stakes. This will minimise any legal and financial liabilities for the party in the long term. It is often performed by brokers who want to ensure that all parties to any transaction are fully informed of the details.

Ultimately, due diligence can be a stressful and complex process for both sides – and a positive result isn’t always guaranteed. But this is no excuse to not complete due diligence because the only thing worse than entering a blind deal is to regret it later on.