Buying a Business: Practical Due Diligence Guide

If you are buying a business, follow these steps to reduce risk and make better decisions.

Should you start or buy a business?

Most of us dream of being our own boss. After all, most people think that they can do a better job than the person they’re working for.

We can look at starting a business from scratch, possibly as a side hustle first, or jumping straight in and paying for an established business. This would require us to give up our day jobs and exposes us to significantly higher risk.

If you have a supportive partner on a reasonable salary, this certainly helps give you time to settle into the business and start making a reasonable return on your efforts.

So, you’ve considered all your options and decided that you want to buy an established business.

What do you do next?

2. Sign confidentiality and review the info pack

Having satisfied yourself that finance is likely to be available, and you see a business you like, the next step is to sign the business broker’s confidentiality agreement and look at the information memorandum prepared by the broker.

If you’re happy with what you think you’re getting and the price, you obtain a draft contract for review by your solicitor.

3. Use a solicitor for contracts and lease review

The next step (if you haven’t already) is to engage a solicitor to review the contract and, importantly, the lease. A solicitor should guide you in the purchase process in much the same way they would if you were buying property. The contract should always be “Subject to Finance” and, importantly, also “Subject to Due Diligence”.

4. Commission an accountant for due diligence

Due diligence is performed by an appropriately qualified accountant. The main objective is to ensure that what has been presented as profitability is materially correct and that what you’re seeing is what you’re getting.

Whenever I do a due diligence for a business, I liaise with the vendor’s accountant and obtain at least the last two years’ financial statements, plus the current period’s management accounts. I also ask for two years of tax returns as well as two years of BAS/IAS lodgements. Importantly, I ask for the last two years of the ATO Income Tax Account and the ATO Integrated Client Account. This, among other things, tells me whether there are cash flow issues.

Due diligence checklist (accounting focus)

• • Last two years’ financial statements.
  • Current period management accounts.
  • Two years’ tax returns.
  • Two years’ BAS/IAS lodgements.
  • Last two years of ATO Income Tax Account and Integrated Client Account.
  • Asset and stock verification.
  • Lease documents and rent history.
  • Any contingent liabilities or undisclosed debts.

5. Analyse the data

Analysis of the data supplied comes next. Normally, there would be “add-backs” to the accounts. As an example, if the vendor has a business loan that the buyer is not inheriting, then interest on that loan should legitimately be excluded as it won’t be borne by the buyer.

We also carefully look for any trends. Are sales growing? Are margins shrinking? Is there difficulty getting staff? Are we likely to lose staff if there’s a change in ownership? Is the lease solid and affordable?

Is this industry affected by cash sales? Is the current owner telling us that sales are really higher because cash sales are not declared or reported?

Are the owners currently hands on and not drawing a true salary from the business? We would need to adjust for this as we’d be likely to need to employ someone and pay them to do what the current owner is doing free of charge.

Finally, we need to carefully check that all the assets that are included in the sale price are actually owned by the business and not just lent to or hired by the business. We also need to check that the stock value is substantially correct.

6. Valuation review and budgets

Having done all this and arrived at an expected annual profit figure, we then compare that to the asking price for the business. While we are unlikely to do a formal valuation per se, we can give an opinion on whether the asking price, in our opinion, is reasonable. We can then also help create budgets for the next two years to assist with the finance application.

Complexity and buying a job vs a business

How complex this whole process is, depends in large part on the size of the business. It’s also important to distinguish whether the buyer is buying a business or buying a job. If you’re buying a business that will give you a reasonable “salary” for the work you do but not much more, then you’re buying a job. If, on the other hand, the business is expected to make significant profit after paying you, then you’re buying a business. Having said that, please be assured that buying a job can be a very rewarding experience.

When to call Depoltz Accounting

I would strongly recommend that the time to come and talk to me is when you’re thinking of buying a business. This would allow me to guide you right from the start in the whole process and make sure that you start off on the right foot.

Experience has shown that people who go into something with their eyes open and with all the facts do much better and have a much greater chance of survival than those who jump in and hope for the best.

A little patience and the right professionals will enhance your chances of long-term success.

Need help with due diligence or buying a business? Book a free consultation with Depoltz Accounting or call 07 3715 8711.