The Due Diligence Steps You Need to Take Before Buying a Business

A purchase of a business represents an exciting time. But, if you're to reap the rewards of such a purchase, it's crucial to buy the right business. Indeed, whether you're buying a manufacturing business in Mississauga or a grocery store in Toronto, due diligence is key to making the right selection.

The due diligence starts usually after you've held meetings with the seller, conducted formal negotiations, and agreed on a price and timeline to buy the business. Due diligence allows you to test your expectations, make sure there are no sore points, and confirm that your initial valuation still makes sense. It’s a process that requires a team effort, including consulting third parties like, solicitors, accountants, banks, inspectors, appraisers, brokers, and others as required, that can assist you throughout this complex process. You’re trusting what you’re being told by the seller, but you're also verifying, making sure the information matches the reality. Here are some basic steps to due diligence when buying a business.

1. What are you buying

Are you buying the assets of the business or buying the shares of the company? What do the assets include, equipment, chattels, fixtures, goodwill, leasehold improvements, inventory, and so on? Are you buying 100% shares of the company, which includes all the liabilities too, what are you getting into?

Does the purchase price include the inventory of the business? Are you buying the business on leased premises or buying a business with real estate? These are some of the questions you need clarity.

2. Consider the Organizational Structure

To begin, you'll need the business's organizational chart. It should include all its divisions, trademarks, and brand names. Plus, you'll want a full roster of its employees and a list of their salaries, and who’s responsible for which tasks. Additionally, investigate:

1. Who leads each division?
2. Who reports to whom?
3. How many full-time and part-time workers are there?
4. Which outside suppliers, manufacturers, and independent contractors do the company partner with?

Likewise, look over all the policies and documents that affect staff members, among them employment contracts, human resources forms, payroll documents, insurance forms, severance pay, and tax documents. What types of benefits does each team member receive? How are retirement plans structured?

3. Think About the Business Model

Once you understand how the company is structured, you can turn your attention to its business model, and a detailed description of how it operates. That is, how does its workforce manufacture, sell, market, and deliver its products? To assist with this step, you should ask for:

1. A complete list of all current services and products.
2. A description of how the company complies with all applicable business laws and regulations (regarding licensing, permitting, insurance, and so forth).
3. The marketing plan, with descriptions of target demographics, market penetration, and strategies for competing with similar businesses.
4. The articles of incorporation and bylaws, along with any amendments.
5. A list of shareholders, investors, and other vital stakeholders.

4. Scrutinize the Finances

When you're perusing a company's financials, you'll want the big picture as well as the tiniest of details. That way, you'll have a true sense of its total value, overall cash flow, annual expenses, both variable and fixed profit margins, and all outstanding liabilities and debts. In fact, you'll want to look at every single product and service that this business offers. Find out each one's rate of return. Of course, to complete a thorough investigation, you'll need every financial document you can obtain. They include but are not limited to:

1. Financial statements for the last five years that include Income statements, cash flow statements, balance sheets, accounts payable, and receivable.
2. Credit reports.
3. General ledgers.
4. Inventory list of all the items.
5. Any gift cards issued to customers.

5. Inspect the Land, Buildings, and Equipment

At this point, the list of the company's physical assets will be useful. It should identify every vehicle, piece of equipment, chattels, fixtures, warehouse, store, and office building. It should tell you the location, rent types, and current market value of each item.

Moreover, you might want to inspect, with your inspector each brick-and-mortar building and piece of real estate and/or assets, equipment, chattels, and fixtures that the business owns. That way, you can verify the condition they're in.

6. Look Over the Contracts

A potential business buyer should pay special attention to contracts. After all, if you acquire a business, you might assume every legal obligation it has. Thus, you must be certain you can fulfill such contracts as:

1. Head or Sub-Lease with the landlord.
2. Collateral agreements,
3. Equipment loan or other agreements.
4. Mortgages.
5. Landscaping, snow removal, elevator service, and so on.
6. Promissory notes.
7. Security agreements.
8. Non-disclosure agreements.
9. Non-compete agreements.
10. Letters of intent.
11. Distribution contracts.
12. Stock purchase agreements.

Furthermore, you ought to read over the standard contracts that customers receive from this business, including warranties, billing invoices, and purchase orders. Then you can decide if you want to alter them in any way.

7. Study the Customer Data

Now you'll want to take possession of a full customer database and any formal customer research reports that the business has completed. With these documents, you could answer such questions as:

1. Who buys from this business?
2. Where do those people live?
3. What demographic groups do most of these customers fall into? What can you glean about their ages and backgrounds?
4. Do these customers usually buy things online or in person?
5. How many repeat customers does this company have? On average, how often do those individuals make purchases?
6. What types of discounts, sales, or coupons seem to attract new customers?
7. Do sellers have approval from these customers for email communications, offers, etc.?

Beyond all that data, learn how the company stays in touch with consumers, whether it's through email, social media, text messages, or other communication methods. And look at some of the correspondence between the company and its customers. Read online reviews as well. Does the feedback tend to be positive?

Also, your solicitors should verify ahead of time that this business isn't facing any lawsuits or other legal actions. The federal or provincial government shouldn't be investigating this company for wrongdoing, either.

8. Conduct other due diligence:

1. The financing condition, essentially tells a Seller that your offer to buy their business is conditional on the buyer obtaining financing.
2. Buyer’s solicitor condition, for multiple other due diligence including but not limited to zoning verification, title search, review of the APS, lease review, and so on.
3. Customer-related policies, financing plans, return policies, refund policies, store rules, and so on. Then think about whether you would keep these policies in place, tweak them somewhat, or change them.
4. All insurance coverage and policies of the business.
5. All professional licenses and permits.
6. Pending litigation or threats of litigation.
7. All company’s patents, trademarks, and copyrights
8. Product inventions, formulas, recipes, or technical know-how.
9. Company’s brand identity, including logo, website, and domain.
10. Companies phone, fax, email, website, social media pages that need to be assigned in buyer’s name.
11. ?Zoning verification and present use confirmation from the city.
12. Title search and other searches are to be executed by the buyer’s solicitor.
13. Property tax, condo fees, rent types, who pays taxes, maintenance, and insurance (TMI). What does the rent entail?
14. Any default in rent payments by the seller, if the purchase includes the sale of property, verify if any property tax, and or condo fee arrears to the city or condo board.
15. Who pays for the lease assignment cost?
16. Training or transition period by the seller?
17. Address who owns working capital, Accounts payable, and receivable.
18. AGCO approval, lottery, LLBO, and cigarette licensing.
19. Franchise approval, signing of Franchise disclosure documents.
20. In a franchise business, verify royalties, franchise fee, franchise assignment fee, renovation cost, renovation timeline, 1st right of refusal, franchise approval process, and distance between two franchise locations.
21. Receive existing business, supplier list, and details of their terms and conditions.
22. Review one year of existing utility bills, including but not limited to heat, hydro, water, phone, fax, security system, and camera, making sure to have these services assigned in the buyer’s name before closing.

Once your due diligence is completed, review the terms of the sale and your offer price to ensure you still feel it is a good purchase and a viable investment. In the end, whenever people are looking at businesses for sale with or without property in Ontario, the due diligence process can spare them from nasty surprises and lost revenues. When done correctly, it could mean the difference between a failed new venture and an enterprise that thrives long into the future.

Always remember, it’s not who starts the game but who finishes it successfully!

Disclaimer: The author of this article, Sarnail Singh, is not responsible or liable for any such comments. My articles are provided just for your reading pleasure. If you decide to rely on them for any purpose whatsoever, I will not be held liable, and you do so at your own risk.