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If you’ve ever thought about buying a business, you’ve likely heard the phrase “due diligence.” It refers to the process by which buyers analyze everything that’s going on with a target company to assess potential risks, liabilities, and opportunities. Through a review of the financial record, contracts, operations, and market forces, buyers can answer very specific questions about a business’s past performance and future potential.

This article provides an overview of things that buyers can do to ensure that a business acquisition is thoroughly vetted. Whether you are an experienced entrepreneur or just starting out, knowing how to perform due diligence is a must if you want to reduce risk and maximize the chances of a successful acquisition. Here’s how to do it.

Let The Inquisition Begin!

Doing your due diligence begins by asking the right questions and gathering sufficient information to avoid taking unnecessary risks. These questions should cover financials, operations, legal issues, and customers. Ask about things like diminishing profits, supply chain management, inventory control, number of employees, outstanding legal issues, clientele, and market demand. This information will allow you to make informed choices and build trust in the transaction process.

Prepare a list of questions that cover these areas and others before making any offers or signing any contracts. Do some research or, better yet, speak with a business attorney experienced in mergers and acquisitions if you are unsure of what questions to ask or whether your list is comprehensive.

Common Pitfalls And Risks In Business Transactions

A lot of business owners who have been through a bad merger or acquisition will say it was because of mistakes that could have been avoided. The vast majority of these mistakes could be categorized into one of the groups below:

1. Poor Communication

One of the most common mistakes companies make is a lack of communication and documentation. When verbal or written communication is imprecise or confusing, it often leads to conflict, delays, or cancellation of the transaction. It also increases the likelihood of the transaction being risky and opens the possibility for future litigation.

2. Insufficient Research

As was previously mentioned, failing to perform sufficient due diligence prior to entering into a transaction is a second common mistake made in the course of business transactions. This includes researching the reputation of the other party, gathering financial information, and searching for potential liabilities or risks before entering into the transaction.

By not performing your due diligence, you run the risk of entering into an agreement with an unqualified and financially irresponsible individual, which could lead to financial losses and the eventual demise of your business.

3. Inadequate Controls

Not putting strong controls in place to stop fraudulent activity is another error committed during business transactions. A business might issue a fraudulent invoice, engage in identity theft, or receive counterfeit or substandard products or services, leading to substantial financial repercussions. In order to prevent losses, it is necessary to have strong internal control mechanisms that monitor transactions regularly to detect any issues and avoid losses.

4. Changing Conditions

Outside factors like changes in the economy, politics, and laws and rules can also pose risks to business transactions. When these factors change dramatically, market disruptions, currency fluctuations, and the legality of transactions can all have an impact on the outcome. Businesses need to be aware of changing conditions and quickly adjust their strategies in order to reduce the risk of transaction failure.

Is The Business Healthy?

When considering the purchase of a business, it is crucial to have a thorough understanding of the potential legal and financial implications involved. Failure to do so may result in you purchasing a business that is not viable or profitable.

Legal Factors: From a legal standpoint, it is essential to review all contracts, agreements, and licenses associated with the business. This includes examining any existing leases, customer contracts, and employment agreements. It is also important to assess any potential legal liabilities or pending litigation that may affect the business. A thorough legal review can help buyers make sure they understand any obligations or risks they may inherit.

Financial Factors: Financial implications are another crucial aspect to consider when buying a business. Buyers must thoroughly analyze the financial statements, including profit and loss statements, balance sheets, and cash flow statements. This will shed light on the company’s profitability and overall financial health.

Buyers should also evaluate any unpaid obligations or liabilities that might affect the company’s ability to maintain its financial stability. This includes evaluating existing loans, credit lines, and tax liabilities. By conducting a comprehensive financial analysis, buyers can gain valuable insights into the business’s worth and ROI potential.

By carefully assessing the legal and financial implications of buying a business, buyers can reduce any potential risks and make informed decisions that align with their long-term goals and objectives. Seeking professional advice from legal and financial experts can also provide valuable guidance throughout the buying process.

Red Flags To Watch Out For When Buying A Business

There are more than a few things that buyers should be aware of and pay close attention to while conducting a business transaction. Not recognizing these red flags can lead to costly mistakes and time-consuming delays. Here are some red flags to watch out for when purchasing a business:

🚩Be wary of a sudden loss of profitability. There may be hidden problems underlying this, and it would be wise to have a closer look as to why these are occurring.

🚩Beware of shoddy accounting systems or the lack of any accounting systems at all. Inaccurate, outdated, or missing financial data can be a sign that the business is not being run properly, or that the business owner is unethical. Insist on receiving books of record and get an engagement letter for a certified public accountant to check all of the records right away.

🚩Be cautious of sellers who don’t want to answer all of your questions. A lack of transparency or willingness to provide information is a clear red flag. Any seller who refuses to comply with what the buyer has requested might be hiding something that makes the business of questionable value or legitimacy. Specifically, data or requests such as:

  • Customer lists
  • Supplier lists
  • Marketing leads
  • Intellectual property
  • Physical inventory
  • Lease documents
  • Patent templates or other intellectual-property documentation
  • Annual financial return or statement

🚩Watch for warning signs, such as a sudden drop in revenue or profitability, that could make the business less appealing as an acquisition target.

🚩Another red flag is when a seller refuses to let prospective buyers speak with current employees or customers. The implication is that the seller is afraid you will discover something about his business that he would rather you not.

🚩Before purchasing, conduct a thorough investigation to ensure there are no underlying issues, especially if the company has a history of legal, financial, or outstanding lawsuits. There is a chance that buyers may be held liable if the company runs into legal trouble or has problems with its assets, which could lower its value. Review any pertinent legal documents and consider consulting with a legal advisor.

🚩Be wary of any seller who is rushing you into a commitment before the proper due diligence can be completed. If a seller is overly eager, or seems desperate to close the deal, it could be a sign that there is something you should be concerned about.

Buyers need to take the appropriate measures to guard themselves from bad deals. By keeping an eye out for red flags, doing your homework, and following your gut, you have a good chance of avoiding a deal that is not right for you.

Why Having A Business Lawyer Is Essential

Buying or selling a business is not an easy task, so you need lawyers to guide you and help you avoid any problems. For this reason, a business law firm plays an important role in both buying and selling businesses. In order to stay out of legal hot water and on the right side of the law, every company needs the assistance of a business law firm!

  • Research help: Business law firms perform due diligence on behalf of their clients when purchasing or selling businesses. This includes reviewing all relevant financial and legal documents thoroughly to uncover any potential liabilities or risks. The attorneys will check all paperwork, including licenses, contracts, and leases, to make sure it is in order and to make sure neither party is caught off guard.
  • Contract help: A business law firm is indispensable for transactions involving the negotiation and drafting of purchase or sale agreements. These legally binding contracts include all of the necessary information, including but not limited to price, payment terms, warranties, and other relevant details.
  • Compliance help: A business law firm can also help with tax issues, industry-specific regulatory requirements, and any registrations, licenses, or permits that may be necessary for the transfer of the business.

If you are looking to buy or sell a business, then you need support from a business law firm to help you through the process with sound legal advice. At Sierra Crest Business Law Group, we offer a wide range of legal services to protect business owners and their companies, including the purchase or sale. The sale or purchase of a business is a milestone event in the life of a business, and we have experience helping clients navigate any legal issues that may arise during the transaction.

Our attorneys will guide you to address any potential issues that arise during the transaction so that it goes as smoothly as possible. To speak with an attorney, please call today.