Conducting Due Diligence when buying a business (Australia)

Buying a business, whether small or big, is a significant undertaking.

Generally, a lot of money is paid for the business and there are many traps. The purpose of this booklet is to identify some of the things might be considered by you as a prospective purchaser. As business purchase lawyers we have seen many people buy and sell businesses and some proper due diligence is key to a good acquisition and hand over.

The booklet is divided into two parts:

1. Practical things worth considering
2. Legal aspects of buying a business

Practical Tips

Why is the seller selling at all?

This is a key to finding out the current condition of the business and establishing how decisions have been made in the business in recent years. People sell businesses for a variety of reasons and it quite often can affect how the business has been operating in recent years. If a seller is looking for a high sale price they may have made certain business decisions such as excessively cut costs and push hard for revenue and this may not be sustainable for the long term. Other reasons for selling are ill health and retirement and both of these can greatly affect if the business has been running to full capacity and with sufficient energy behind the business.

Market Conditions and Business Cycle

Is it a good time to be buying into this type of business? Are you buying at the of the market?

Are there things on the horizon that would indicate that the industry may under pressure in the near to medium term? Not being fully aware of the market conditions and trends can leave you exposed a perfect example of this is when a prominent publicly listed Australian law firm purchased an overseas practice to find out less than a year later that laws where changing that significantly affected  the value of the business and sent the Law Firm into administration.

Aside from uncovering the inner workings of the business you should do further research of the external considerations and forces such market conditions and look for upcoming or potential legislative requirements or changes. Check the products and suppliers that may affect the viability of the business. Due diligence shouldn’t just be concerned with the micro details but the macro ones as well. Check your competitors and what they are doing too – are rival products or services coming that will be a threat to the business. Trend based businesses may not have the longevity of other businesses and be sure you are familiar with the business cycle to determine cashflow.

A due diligence clause is typically inserted into business sale contracts when requested from Purchasers so that they can investigate and make enquiries about the business before the contract goes unconditional. The scope of a due diligence clause can help set out the framework for what is to be provided as a part of your due diligence. A lawyer will be able to draft a clause suitable for you to protect your interests. Ensure you obtain legal advice as some clauses presented to you by a broker may not have your interests protected.

As a purchaser you should carefully examine the business in detail so that you can accurately assess the value of the business and the risks you may face with buying it.

It shouldn’t matter if the business is a franchise or an established business both need equal diligence when making an investment.

The due diligence period is your chance to ask some hard questions and about the business and, done correctly, can be the difference between purchasing a business that makes money or losses money.

This is your opportunity to check that the Seller is in fact representing the truth about the business and the figures are accurate.

If the seller won’t agree to a due diligence period; or won’t introduce you to their suppliers, landlord or real estate agent; or does not disclose relevant information to you (such as their financial statements, or evidence of key licences and permits), it may be cause for concern and you should only proceed with great caution.

You should be concerned if a seller is not co-operative or trying to withhold information and some warning signs are:

• Refusal to disclose important information or documents or avoids answering questions you ask
• They are unwilling to enter a due diligence period or limit the access you can have.
• They won’t introduce you to their suppliers, landlord or Key business contacts.
• If they have been or are involved in legal proceedings.
• The seller is pushing to close the deal quickly.
• They have a questionable credit record and history or reputation.

It could be that you will get a great bargain if you are buying a business under duress however you should be certain of the business operations and financial position and the legacy you will inherit with the business.

Confidentiality

As a purchaser you may be asked to sign a non-disclosure agreement. This will ensure that you treat the information that you are provided with confidentiality.

Advisors

You will no doubt get advice, wanted or not, but in doing your due diligence, you should always getindependentadvice from business lawyers, accountants or business valuers on the contracts, documents and financial situation of the business. Be sure to go with advisors that you trust and not just with the recommended advisor. They should be independent and work for you.

During this time you should also consider any other terms and conditions that you may need to take into consideration when buying the business. Your due diligence period can really affect the amount you would like to pay for the business and will be a good indicator as to how the handover period is handled.

Market Conditions and Business Cycle

Aside from uncovering the innerworkings of the business you should do further research of the external considerations and forces such market conditions and look for upcoming or potential legislative requirements or changes. Check the products and suppliers that may affect the viability of the business. Due diligence shouldn’t just be concerned with the micro details but the macro ones as well. Check your competitors and what they are doing too – are rival products or services coming that will be a threat to the business. Trend based businesses may not have the longevity of other businesses and be sure you are familiar with the business cycle to determine cashflow. Not being fully aware of the market conditions and trends can leave you exposed a perfect example of this is when a prominent publicly listed Australian Law Firm purchased an overseas practice to find out less than a year later that laws where changing that destroyed the price of the business and sent the Law Firm into administration.

• Administrative
• Assets
• Software
• Hardware
• Equipment & Leasing
• Intellectual Property
• Financia

Checking the integrity of the financials of a business is difficult if you are not fully qualified. Advisors should be able to provide assistance with the details of the business and also on the short, medium and long-term financial forecasts for the business. You should have a clear point of when your investment should have paid for itself and what other costs you may incur at each stage.

Legal Structure of the business

Legal Documentation

The legal structure of the business is important to understand along with the true ownership of assets and liabilities.

Checking the compliance issues in a business is critical.

You should also pay a great deal of attention to the contracts and agreements in place and look at the detail of terms and conditions and how this affects how you may wish to run the business. Lease agreements, employment contracts, licences and permits may restrict your use or rights and should be investigated fully to know your exposure especially for key documentation.

Key documents include things such as:

• Licences
• Permits
• Leases
• Contracts
• Insurance
• Company Shares & Shareholdings

A Lawyer is the only person fully qualified to give you advice on the contracts and agreements and accountants and other advisors have separate and different skills and offer advice on the financial aspects of the business.

Government and Regulatory Bodies & Compliance

Different industries have differing regulatory bodies and compliance issues. A check should be done on those key organisations that govern the business or affiliated bodies. Often times these bodies may have disciplinary powers or be able to impose restrictions on the business. You should take care to check what issues have arisen in the past or if there are presently any compliance issues.

Some issues that may affect a business are:

• Licences
• Permits
• Taxes
• Environmental Concerns

Human Resources

This should be a detailed audit and encompasses checking such things as the documentation of staff, payroll and tenure of staff through to the Occupational Health and Safety compliance in the business and tax obligations. Employment Agreements and Pay and Pay Entitlements, bonuses must be checked also with review processes and any relevant employee history such as disputes, expectations and performance etc. Retaining key valuable staff and having a good understanding of the roles in the business will ensure a smooth handover.

Sales and Marketing

The core of any business is to bring a product or service to a market and this process is critical when evaluating a business. The strengths and weaknesses found in these processes will determine how successful and effective the business is or could be.

Customers

Good Will = Customer Loyalty & Brand Strength

Good will is the “x factor” value that can attributed to a business for their brand and customer relationships and loyalty and reputation.

The real consideration for a prospective purchaser is whether this goodwill is transferrable to the you as the new owner or whether it follows the individuals in the business. This is of greater concern where the business relies on a few key people and their reputations and relationships so it is prudent to check how the customers are sourced for the company and whether they are loyal to the brand or the person.

Management Style & Culture

This is an important consideration to take into account especially when planning a handover and sorting out how to manage the change. The current management style and processes should also be considered as this is greatly impacted. There will need to be close attention paid to introducing new management style to an existing team.

Gaps & Opportunities Analysis

If there are gaps or opportunities that are identified in your due diligence stage you should create a list and then you go on to create a plan of how to close any gaps or take advantage of the opportunities that you see.

Strategic Planning & Capacity

You should also be checking holistically where there is capacity in different areas of the business to expand or if further investment needs to be made to grow the business. Each business operation at different levels of capacity with some running to full capacity and some under capacity. Knowing where there maybe some underutilised resources or potential in the business can help develop a plan for growth. Strategic Planning due diligence will give you an indication of where the vision and direction of the business has been and whether this vision aligns to what you wish to do in the business.

OurBusiness Law team will be more than happy to assist you throughout your due diligence period, to help put your mind at ease on during this important purchase.

Call us now on 1300 907 335 or complete the contact form for a confidential discussion about your proposed business purchase.