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Buying a Business – identifying potential risks and doing your due diligence

Carrying out due diligence prior to acquiring a business allows you to assess its current financial and operational status, and evaluate the company’s likely success in the future. Taking due diligence measures also helps in assessing the true value of a business – it uncovers potential risks and threats, and enables you to take mitigating action if necessary.

Due diligence is generally carried out when an offer has been made and accepted, but before a legally-binding agreement is signed. The seller may be willing to provide an ‘exclusivity period’ during which the business is taken off the market, whilst you complete your due diligence checks.

Confidential information

You might need to sign a non-disclosure agreement before any confidential data is released, however - this type of information is commercially sensitive, and the seller will want to prevent it falling into the hands of competitors.

It is advisable to seek the help of a finance professional when carrying out due diligence. They will offer valuable commercial awareness, and be able to provide a reliable opinion on whether purchasing the business is the right thing to do.

Begbies Traynor offers extensive professional advisory services throughout the UK, and is available to carry out due diligence measures if you are thinking of buying a business.

Categories of due diligence

Due diligence for business acquisition can be broadly divided into three categories:

  • Financial
  • Commercial
  • Legal

Financial

Financial due diligence involves analysing the company’s books in order to verify the information you have been given. Investigating the assets and liabilities of a business enables you to negotiate on price if necessary, or withdraw from the deal if too many adverse elements come to light.

Your professional advisor will look at:

  • Profit and loss statements
  • Balance sheets
  • Tax returns
  • Bank statements
  • Records of sales and purchases

Some points to keep in mind

  • Whether the business collects its debts effectively
  • Level of bad debts previously experienced
  • If the company pays its own debts on time
  • Profit margins

Commercial

You will need a list of customers to establish the demographic of the company’s main customer basis, as well as a list of suppliers to ensure there is not too much reliance on a single source of supply.

The company’s marketing strategy should be looked at, as well as to what degree each customer contributes to the overall business turnover - additionally, whether the loss of a key customer would be particularly damaging.

Other elements of commercial due diligence include:

  • The level of customer satisfaction/complaints made against the company
  • If customer retention could be an issue following purchase
  • Assessing the level of competition
  • Identifying any adverse publicity
  • Quality of the workforce and management
  • Effectiveness of the stock management system

Legal

Current or potential litigation against a company can have a severe impact on its future revenues and anticipated profits, particularly if there is also adverse publicity. Common reasons for litigation include non-compliance with industry regulations, health and safety or environmental issues, or a disputed debt.

Other areas of concern include:

  • The level of customer satisfaction/complaints made against the company
  • If there have been any staff issues in the past
  • Whether the company owns the rights to its intellectual property
  • Customer/client contracts
  • Previous record of tax compliance
  • If insurance policies and any necessary licenses or permits are current
  • Risk assessments and health and safety audits 

Identification of potential risks before purchase

These measures are not exhaustive, and clearly, may not apply to all businesses. Others will require additional checks to ensure that a purchase is worthwhile, and that industry or sector-specific issues have been fully addressed to the satisfaction of the buyer.

Once these due diligence procedures are complete, any potential risks of buying the business should become apparent, enabling you to make an informed decision on whether to proceed with the purchase.

Full awareness of the obligations that will be taken on if you go ahead is crucial, so that ‘hidden’ commitments and responsibilities do not derail your plans for the future.

Begbies Traynor is the UK’s leading professional services provider, and can offer valuable insight if you are buying a business. We will provide expert commercial insight to ensure your decision is based on sound information. Call one of our licensed insolvency practitioners to arrange a free same-day consultation.

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