"Due Diligence, The Unreasonable Way"

Should you buy it? Is it worth the price? The reasons for conducting a due diligence is to make sure you are receiving the business you are buying in the condition the Seller presented it to you, also to uncover any surprises that might pop up later or to uncover any unexplained liabilities. It is your responsibility to do the due diligence process. n
It’s okay to get outside help, such as your accountant or atto
ey. It will ultimately be your judgment call when the process is finished and it should be. After all, you will be the new captain and it must feel comfortable to you.

A lot is said about the due diligence process and it is an important part of the buying process, but in actuality, the due diligence process should begin on your first look at the business. Everything you do leading up to the letter of intent will be questions leading you and the Seller into the due diligence process.

That’s why you should keep good notes during the meetings with the Seller or broker. If they give they figures or make statements about the business, you are able to search your notes to make sure you getting the figures you discussed early on. During the process, you need to have complete access to all the books and financial records. You are trying to uncover hidden skeletons.

1. Possible loss of major accounts. Relative or friend may be major account.
2. Increase in lease payment for building, or not long enough lease.
3. New competition moving in ( major chain stores).
4. Difficulty in getting inventory or services.
5. Zoning changes such as a new by pass, or limited expansion.
6. Franchise fees changing, or transfer fees too high.
7. Image and reputation in trade area hurt by bad reports.
8. Business volume slipping in last half of year.
9. Credit problems with suppliers and vendors.
10. Law suits and liens against the business.
11. State and federal law violations. Unpaid taxes. License suspensions.
12. Old or dead inventory and equipment, major replacement cost.
13. Partner or spouse who may not want to sell.
14. Environmental and safety requirement violations.
15. Key employee replacement problem, labor union problems.
16. Potential increase in product related liability insurance.
17. Contractual agreements or relationships. n n
Remember you don’t have any cash money to put down. What do you do? Submit an earnest money deposit as low as you think will work. You might have to raise it a bit later but if the Seller is anxious to sell he might not pay much attention. Remember, with the out clauses you have included, you won’t have to go through with the deal anyway. You just don’t want to have a Seller or broker tie up any of your cash. Here’s how you get around depositing earnest money with the Seller or his broker.

Do not include a check with your contract to the Seller. The contract Agreement will state that the earnest money has been deposited with your atto
ey as an escrow agent. Write a post dated check with the agreed upon amount and the agreed upon closing date, made out to the Seller. Do not date the check for the date you write it, instead, use the closing date. deliver the check to your atto
ey. Tell him not to deposit it but to hold it. The Seller or broker doesn’t know that the check is post dated. There is no way the Seller could retain the earnest money anyway because of the out clauses in the contract. The main thing to remember is, never give the earnest money to the Seller, to the broker or to their Title Company. n
In most cases, you should prefer to buy the business through transfer of assets. There will be instances where you might want to take over a corporation. For instance, your personal credit might not be up to par and if you can acquire an on going business with a stock option and assume the assets and liabilities, this could be to your advantage. You might not have to provide financial information to landlord and suppliers when you do a stock option. Make sure that the owner of the business hasn’t co-mingled other business activities with the business you will be purchasing. Have the Seller sign a strong indemnification clause.

Of course this clause is only as good as the Sellers bank account. If a prior problem did come up because of a prior act of the Seller, you as a new owner of the corporation would be responsible for any amount that the Seller cannot pay. This is why most buyers will not purchase the corporation stock when buying a business. If the Seller will not pay, or correct the situation, it becomes important for the buyer to have a right of offset clause against the buyers note to the Seller for any claim arising from past actions of the Seller and stock holders of the corporation.

If the Seller refuses to correct the problem, the buyer can pay the claim and deduct the amount from his note payment to the Seller. I strongly recommend that you get both your atto
ey and accountant involved with a corporate stock purchase of a business. Get them involved early in the process. It’s better to be proactive then reactive. One more word, it costs less to do it right the first time, than to go back and fix it.

When you decide to acquire the business through an asset sale, instruct your atto
ey to set up the transfer, so that the corporation sells the assets to you. This means you don’t buy the stock. You buy the business. I do recommend that the sale be set up as an asset sale rather then buying the stock. The next step is to identify the assets and agreements that will make up the sale of the business.

The goal now is to assign portions of the purchase price to the assets and agreements that are to be conveyed as part of the business sale. As a Buyer you want to apportion as much of the purchase price of the business to items that can be expensed, rather than to depreciable assets. This will provide you near term write off of those portions of the purchase price. Have your accountant involved is these assignments. Now that the structure of the business sale has been determined, the next thing you want to identify is agreements that will be required to be executed by the Buyer and Seller.

Covenant not to compete, It would be a disaster, if you purchased a business, only to have the Seller or a stockholder open a competing business across the street next month! That’s why you have Sellers sign a covenant not to compete agreement. This agreement must state the geographic area and a time period that the Seller will not conduct business doing a similar type business like he is selling. It should not make any difference to you if the Seller is 90 years old and is retiring or moving away. Get the covenant not to compete signed.

Consulting agreement You should consider the importance of having the Seller stay on for a period of time after the sale closes as a paid consultant. You should get the first thirty days at no charge. That might be enough time for you to understand the business and to able to find the bathroom. If it’s a business that you’re not familiar with, work out a consultant agreement. Of course the terms and conditions are open to negotiation. As a Buyer you want the Seller to stay on in the business for as long as possible with low compensation. You have to make this call depending on your comfort level.
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