Why due diligence is important when buying a business
Posted on 30 November 2022
Why due diligence is important when buying a business
We all know the importance to conduct due diligence when buying a house. Whether it be a building and pest inspection or searches in the Council approvals for extensions or a detached dwelling. Common sense, right?
So why do we sometimes forget this step when buying a business?
Buying a business can be risky and much like a property contract, a business purchase contract can provide the Buyer with an opportunity to conduct due diligence into the Business.
In Queensland, it is the buyer’s responsibility to obtain due diligence on the business they are planning to purchase.
There are 5 key areas to focus on to avoid potentially serious issues.
- The business financials such as;
- Records – profit and loss statements, tax returns, income;
- Expenses – utilities, supply agreements, wages, leased equipment;
- Sales records.
- The contract which the business is affected by, such as:
- the lease the for business premise or tenancy agreement;
- employment contracts;
- franchise agreements;
- ongoing warranties and other third-party agreements.
- The relevant approvals required to operate the business such as:
- DA (development approvals) or other Council approvals;
- Appropriate Licencing such as liquor and food licences;
- Business operations including:
- Stock;
- Tools and equipment;
- Policies and procedures;
- Intellectual property.
- Legal Issues such as:
- Compliance with laws and regulations;
- Corporate information about the Seller including historic or ongoing legal disputes;
- Asset ownership.
After signing the contract subject to due diligence, the first point of contact should be your accountant and/or financial advisor. These advisors will help with gathering and sifting through all the business financials.
By signing a contract subject to due diligence, it allows you time to deep dive into the “nitty gritty” of the business you are wanting to purchase. It also helps to avoid financial disaster. No big deal, right?
Not only will comprehensive due diligence help avoid a risky or poor decision which would result in financial distress, but it can also allow you to find out more about any potential weak points in the business (such as undisclosed disputes or upcoming unrealised liabilities). Being armed with this information may even provide an opportunity to further negotiate a fair price for the business due in light of your findings.
But what if the seller won’t allow a due diligence clause?
If the Seller won’t accept your first contract proposal due to the time allowed for due diligence, speak to your advisors to work out the necessary amount of time for the business to appropriately conduct due diligence. If the seller is still playing hardball (without apparent reason) the question then becomes, why won’t they allow your due diligence clause? Is this really someone you want to buy a business from?
So, when do you contact your lawyer?
It’s always a good idea to get in touch with your lawyer when looking to purchase and prior to signing a contract to make sure you understand what your obligations and timelines are upon signing.
While your accountant and/or financial advisor is combing through the finances of the business, your lawyer can at the same time be investigating the other key due diligence areas and any other legal issues to determine what degree of risk the purchase poses.
What will your lawyer look for?
A knowledgeable solicitor will be able to look at the below documents and give you a comprehensive overview of the health of the business from a legal perspective.
Below outlines the types of documents your solicitor should ask to review:
- purchasing contract;
- employee contracts;
- third-party and client contracts;
- intellectual property details;
- lease, loan, mortgage, or other property agreements/contracts;
- insurance history;
- history or any court proceedings or claims;
- relevant director/partners/shareholder minutes; and
- details of current stock and equipment.
It’s important that all your advisors work together to ensure a smooth process for your business purchase which is comprehensive and gives you the best chances of success in your new business.
How can Omnia Legal Assist with your business purchase?
The Commercial and Business Law team at Omnia Legal are trusted advisors that can assist with reviewing and advising in both selling and buying a business. We will liaise with all parties to ensure that the final contract reflects your key interests and protects your new business venture.
This article provides general information on legal topics for educational purposes only, and should not be considered legal advice or recommendations. While we have taken care to ensure accuracy, Omnia Legal is not responsible for any errors, and makes no guarantees about the accuracy or completeness of the information. Links to third-party websites do not constitute an endorsement, and we are not liable for any damages that may result from using inaccurate or incomplete information. It's always best to seek legal advice for specific situations.