Financial Due Diligence Steps to Take When Purchasing a Business

Buying a business is no simple task. It’s a complex undertaking that includes a multi-step due diligence process to ensure the investment being made is a good one.

When taking those first tentative steps into the world of mergers and acquisitions (M&A), it’s important to seek the counsel of professionals who understand the due diligence process.  There are a myriad of ways a deal can fall apart, but anticipating issues and planning for them upfront is a way to make a deal go smoothly from start to finish. Here are steps Lucrum Consulting takes when helping a client examine a potential acquisition:

1. Perform a market review.

   Prior to purchasing a business, it’s important to look at the market, specifically the target company’s competitors. What niches are being exploited and are there untapped opportunities to expand? The goal is to determine if there are opportunities to take a significant piece of the market share upon entering the industry or a market segment to develop. The information gathered during this phase of the M&A process will help determine if the seller’s business is the right fit, at the right time.

2. Let the books do the talking.

   When purchasing a business, it’s important to understand its financial health. To determine the fiscal strength of a company, conduct a thorough review of the seller’s books. Specifically look for red flags; check to ensure that the revenues being reported are supported by paid invoices matched to bank deposits and that the margins make sense. “When we examine a seller’s books, we’re not doing a CPA-type audit or review,” explains Jeff Heybruck, principal at Lucrum Consulting. “Our goal is to make sure the revenue translates into bank deposits, the headcount matches payroll records and if a portion of the business is being purchased, that all activity is properly allocated between the selling and the retained divisions. This gives buyers the validation they need to feel good about their purchase decision.”

3. Plan ahead.

   Businesses often encounter problems after closing the deal because they underestimate the capital needed to succeed. To avoid this pitfall, secure a large amount of working capital, as well as a surplus. This will ensure there is money available to address any unexpected costs that arise. “Buyers of businesses are generally overly optimistic about their purchase. Some get into danger within the first six months because they didn’t plan well enough for their capital needs,” explains Adam Petricoff, managing partner of VR Mergers and Acquisitions. “Therefore, plan ahead, have a cushion and rely on the counsel of consultants like Lucrum Consulting, whose team excels at capital expenditure planning and anticipating any unexpected out-of-pocket costs.”

4. Review material contracts.

It’s not uncommon for companies to have ongoing contracts with outside vendors. Many times, regardless of a change in ownership, these contracts remain valid. Lucrum advises buyers to familiarize themselves with all inherited vendor and customer contracts and fully understand each agreement. Is the projected cost of the contract below or above the current market rates? If it’s the latter, can the rates be re-negotiated? If so, then that could result in an instant cost savings – meaning more money in the bank and one less obligation that needs to be assumed.

5. Examine the customer base.

Some companies provide niche services to specific clientele; therefore, Lucrum asks all buyers to study the seller’s customer base. In business, customers are loyal, not only to a particular brand or service, but also to its leader. So before making the purchase, consider if there will be any issues with keeping the seller’s customer base after the deal is done. Are the current customers so “married” to the owner that they would be willing to jump ship once new ownership is established? If the answer is “yes,” then it may be best to look elsewhere; the business may not be the best match.

6. Evaluate the employee/management structure.

When reviewing the books, prudent buyers are searching for several things. Consistency in management, pay rates competitive with the market and even the company organization chart are important. Inconsistencies in pay rates between same level, skill set and experience employees may signal a problem with the company’s salary structure. Paying below market may be great for the bottom line but employees may be in need of pay raises, and if they are several months or years (yikes!) overdue given the current market, then the buyer could be acquiring a business with a backlog of employee resentment. In this situation, the buyer is not only over paying, but having to deal with the potential of staff turnover at a very vulnerable time. Finally, it’s important to understand the roles each person plays within the organization. It’s been said many times that the generals make the plans but the non-commissioned officers get it done. The same is true for many businesses; there are often employees who are the glue and leaders even though their title or position might not indicate such. The key is to identify the leaders and the followers early on to avoid a surprise later.

“The due diligence process should answer three questions,” says Jay Offerdahl, president of Viking Mergers & Acquisitions. “‘Can you see yourself in the business?,’ ‘Can you improve it?’ and ‘Does it make financial sense?’ The Lucrum team can help answer those questions, making it easier for business owners to concentrate on their business plans and look ahead, not behind.”

Let Lucrum Consulting help you take the next step forward. If you are seeking to grow through acquisition, or recently have purchased a business and want to get ahead of any potential transition issues as you integrate that business with your own, give Lucrum Consulting a call at 704.927.0462.  We are here to help when you need us.