Why do Due Diligence When Buying an Alabama Business in Huntsville?

(This article originally appeared on sarahsshepard.com)

Due diligence is a term that applies to a range of business categories. You can have due diligence when it comes to commercial endeavors, taxes, financial works, legal works, mergers and acquisitions, human resources, customer involvement, employee involvement, and so on.

In essence, it’s a broadly applied term in the world of finances and business.

It’s safe to say that it’s common knowledge that due diligence involves examining and evaluating an entity in some form or another. But what exactly does due diligence mean when it comes to buying a business?

In this article, we’re going to give you an overview of everything you need to know about due diligence when it involves purchasing a business. Keep reading to learn more.

What Is Due Diligence?

By definition, due diligence means “the care that a reasonable person exercises to avoid harm to other persons or their property.” In other words, due diligence means taking the time to do your homework before entering into a contract of any kind or investing in a new business endeavor to ensure that the deal isn’t a flop—and that you don’t end up in a worse place than where you started.

It’s important to realize that due diligence isn’t a quick and simple audit by any means. There are many specific elements involved that easily vary based on the situation and the nature of the business you intend on purchasing. It’s something that can uncover potential financial issues and liabilities before you sign on the dotted line.

 Due diligence isn’t just intended for the buyer either. While it does primarily protect the buyer, due diligence offers protection for the seller as well, ensuring that they haven’t missed anything when evaluating their business, inventory, financial records, and so on.

What Are the Advantages and Disadvantages?

Due diligence is a very valuable risk management tool, so to speak. This type of investigation allows potential buyers to avoid any unwanted surprises post transaction and make well-informed purchase decisions—which is arguably its greatest advantage.

There’s a saying, let the buyer beware, which is formally called caveat emptor. It’s the entire foundation on which due diligence was built upon. More importantly, it means that it is usually 100% the buyer’s responsibility to ensure that the business or other asset that they’re purchasing is in fact up to par with both personal and legal expectations. That puts the buyer in total control.  

However, the due diligence process can be quite lengthy, difficult, and costly. Depending on the business in question and the type of transaction, buyers may need to get in touch with multiple parties, including brokers, accountants, lawyers, and so on.

Each party involved will have a different level of information which means that they will also have incomplete records. The buyer, with the help of a lawyer if applicable, will have to be the one to ultimately review all of the information that each party produces. From there they will have to make additional requests for more information if they aren’t enough details—which isn’t exactly cost and time-effective.

Another disadvantage that stems from due diligence is that it can impact the seller of the business negatively.

For example, the entire process can take away the time the seller needs to run their business when they have to respond to high volumes of document requests and other information questions.

Additionally, should something negative come up in the buyer’s investigation, it could impact the purchase decision or the terms and conditions of the intended contract.

Of course, regardless of the advantages or disadvantages that come up during a due diligence investigation, it’s a crucial aspect of buying a business.

What Is the Due Diligence Process?

The due diligence process requires the work of the buyer and his or her accountant and business lawyer within the time frame between drawing up the intent-to-purchase documents and signage and before the formal purchase agreement is closed.

 Typically, the due diligence process includes:

●      Examining all business records and documents for any liabilities or issues, including sales agreements, purchases agreements, liens, and assets

 ●      Examining any legal documents relating to any ongoing or potential lawsuits

 ●      Examining any concluded litigation

 ●      Spending time at the physical business location speaking with managers, employees, and anyone else involved with the business operations, if applicable

 ●      Examining the sales history against customer lists

 ●      Examining any potential plans for future expansion

●      Examining the condition of the physical property and any of its facilities, including its equipment, furniture, and other fixtures to verify that they match the condition reported

●      Taking detailed note of any discrepancies between what is reported and what you have witnessed with your own eyes

 It’s also important to ask as many questions as is necessary to feel comfortable with the proposed transactions. Unfortunately, it’s sometimes more important to examine the potential negative aspects or risks associated with the business you intend to buy rather than the positives.

You Get What You Pay for

Due diligence can be a long yet necessary step in buying a business. After all, you get what you pay for—so it’s critical that you know exactly what you’re buying, or if the business in question has any major issues, before you close and take on that responsibility.

If you’re buying a business in Alabama, you’re going to need some help conducting your due diligence investigations. Contact us today to speak with an Alabama business lawyer to handle your due diligence and more.