You have probably heard the term before, but what exactly is Due Diligence?
The term is often referred to when discussing the purchase of a business.
Essentially, due diligence is the process of examining the business to assess its value and the risks associated with buying it. When buying a business, due diligence could consist of any, or all, of the following:
Legal Due Diligence
- minutes of directors’ meetings/management meetings
- intellectual assets of the business (e.g. intellectual property, trademarks, patents)
- existing contracts with clients/staff
- partnership agreements
- lease arrangements
- details of credit and historical searches related to the business
- reviewing any franchise agreement attached to the business
- any licences required to operate the business
- whether any equipment which is being transferred as part of the sale is unencumbered
Financial Due Diligence
- income statements
- records of accounts receivable and payable
- balance sheets and tax returns including business activity statements (last 3-5 years)
- profit and loss records (last 2-3 years)
- cash deposit and payment records, as reconciled with the accounts
- utility accounts
- bank loans and lines or letters of credit
- audit work paper files (if available)
- the seller’s claims about their business (e.g. their reasons for selling, the business’s reputation)
- privacy details (e.g. of employees, trading partners, customers)
- details of the business’s automated financial systems
Physical Due Diligence
- details about plant, equipment, fixtures, vehicles (are they in good working order and licensed?)
The extent of due diligence will vary depending on the type and size of the business and may include many more items not listed above.
For most buyers of a business, some basic due diligence enquiries will be carried out during the negotiation process before an offer is made. Following agreement on basic terms, the buyer and seller sign a Business Sale Contract (in Queensland it is generally the REIQ Business Sale Contract). Almost always, any offer will be subject to a due diligence period of anywhere between 14 and 60 days. During this period of time, the buyer maintains a right to terminate the Contract and receive a refund of its deposit, if it is not satisfied with the results of its due diligence investigations. Sometimes, if the buyer is not satisfied, the parties can renegotiate the purchase price or some other terms in the Contract.
It is important, particularly for the seller, that the parties are bound by confidentiality during any due diligence period. See our article on Confidentiality for more on this.
No matter the size or type of business you are looking to buy, carrying out due diligence investigations is essential. We recommend you commence the due diligence process at the earliest possible opportunity.
The Small Business Lawyer specialises in business purchases and sales and can assist with legal due diligence enquiries. If you are thinking about buying or selling a business but aren’t sure about where to go next, book in a free 20 minute consult with one of our qualified small business lawyers.