By Lisa Olson
Due diligence is the process of investigating a company you have plans to purchase. This process starts when you consider the possible purchase of the company and ends when the sale is complete. It is during this time that you will compile the bulk of your due diligence investigation.
What happens if you overlook something in the Due Diligence process? You can’t always rely on intuition and you can’t obviously check everything. That would be too costly.
In a particular acquisition, my biggest mistake was underestimating the current owners talent and charisma to manage the business. In this case the owner was the business and when he left, the revenues plummeted. Due diligence is not only objective but subjective as well. I’m sure great deals have been made on the back of bar napkins, but can you afford to take that kind of risk?
To avoid costly mistakes you have to ask yourself some essentials questions. What is important to me? What issues will be costly? What drives my profits? This process of questioning will minimize any post sale surprises. You must extract certain information from the important areas of the business. This will assist in providing you with a greater degree of comfort and certainty about the future earnings potential of the company.
Secure the following paperwork and documentation.
- Non disclosure agreement
- Confidentiality agreement
- Letter of intent
- Purchase and sale agreement
Gather information categorized in the following four areas.
- 2-3 years tax returns
- 2-3 years income statement
- Balance sheets
- List of company assets
- List of company liabilities
- Partner agreement
- Deed or lease information
- Current business plan
- Fictitious name filings
- Bank statements
- Customer contracts/ long term
- All sales literature/ pricing
- Top 5 revenue customers
- Marketing and Yellow page cost
- List of service offerings
- Sales compensation plans
- Terms of sale (deposits)
- Sales process
- Gross and net sales for five years
- List of employees/hire dates and job description
- Key relationships to customers
- Who are the influencers?
- Labor relation issues
- Changes that have happened
- Consistent payroll
- Telco utilization
- Automated methods being used
After you have compiled all your documentation you can start to have discussions. Talk to the key employees, front line employees, the current customers, ex-customers, and vendors. Get other people’s opinion of the future expectations of the company. Ask the following questions. What economic factors could affect the industry? What are the key factors for a successful operation? Discuss the documentation you have compiled with the current owner. Give the current owner time to prepare answers.
Beware of small business P&L statements. They contain curious business expenses like company owned cars, travel, and relatives on payroll. During your due diligence process you should pinpoint the true value of the business to the owner. That value is the owner’s benefit, the seller’s discretionary cash flow and your potential profit.
After pinpointing the owner’s benefit, it’s necessary for you to develop your own recasting or projections. Take a look at all company expenses and determine which ones really constitute compensation for the owner. In some cases the owner will not want to disclose certain information.
Things to be mindful of:
- Bad Better Business Bureau reports
- Personal matters pertaining to the owner
- New competitors in the market place
- Non renewal of major contracts
- Increase in lease terms
- Potential labor issues
- Unpaid taxes
- Poor management
- Pending litigation
This information should assist you to evaluate the strengths and weakness of the business but no matter how thorough you are there are still risks in purchasing a business. To assist you in minimizing the risks, take the calculation test.
There are certain industry calculation ratio and averages that should be consistent and be considered. You may set your own criteria based on the uniqueness of your business.
For example, consider all the things that you can bring to the business that have a positive impact on the company. Remember, in the end there is no substitute for common sense.
Lisa Olson currently holds the position of director of personal services at Wireless One Network–CellularOne located in Fort Myers, FL. Lisa’s experience includes multiple call center responsibility throughout the country varying in size. She has had the opportunity to work with call center experts such as Arthur Anderson and Deloitte & Touche.
[From Connection Magazine – January 2001]