Due Diligence is what we do to check out a product, service, property, investment before taking the plunge. It can be as simple as reading up on the Consumer Reports, clicking on reviews or be more detailed. It's an effort to now before you go.
Def: reasonable steps taken by a person in order to satisfy a legal requirement, especially in buying or selling something. A comprehensive appraisal of a business undertaken by a prospective buyer, especially to establish its assets and liabilities and evaluate its commercial potential.
I recently have been working on a client's business purchase. My mandate was to ascertain exactly what was being purchased, it's value and spot any oddities or things that don't add up. This particular seller was not forthcoming and resisted my requests for necessary documents. You'd be surprised how convincing someone can be without documentation to back it up. But the black and white is the only thing I pay attention to. Occasionally I need some brief explanations etc., but by and large, i can learn all I need to make good calls for clients. Resistance to providing documentation is a red flag.
An important part of Due Diligence is to use cross checks. A common example is that a P&L gets cross checked against bank statements looking at both income/deposits and expenses. Though some small differences can exist due to depreciation, inventory, and adjustments, the P&L will usually cross check within a reasonable margin of error/difference. When it doesn't, a red flag gets sent up. At that point I may choose to query the noted problem or move on looking at other documents.
A short list of business documents to review and verify includes:
- Profit and Loss Statement (aka Operating Statement)
- Balance Sheet
- Bank Accounts Statements
- Tax returns & any K-1s issued
- Credit Card Statements
- Capital Account Statements and owner Basis Statements
- State filings as to Incorporation and Registrations and any DBAs
- Leases
- Insurance Policies
- Inventory Statements with methodology for valuation
- Vendor lists
- ARs and APs
- Social Media
- BBB Reports
- Dun & Bradstreet Reports
- And more as each case requires
Accountants familiar with Due Diligence for clients can quickly find cross checks, note discrepancies and recognize spurious entries etc. In the end, a report is provided that either confirms all is well or not and notes potential caveats. Due Diligence is often conducted in tandem with an Attorney who has an eye for the legal details. I always recommend that clients purchasing a business interest require a broad Warranty and Representation Statement and an Indemnification for my client/purchaser to be held harmless for anything that came before. This would include statements that all taxes have been properly filed and that any tax is paid in full and that no audits are in progress or notices of same received. That extends to legal actions like pending lawsuits etc. This can get detailed if patents, copyrights and proprietary processes are involved. A seller who will not provide such a Warranty ay well be hiding something.
On average, I spend about 12 hours conducting Due Diligence and writing up my findings. Some more some less but that's an average. If an Attorney is working with me it can vary up or down but as a rule it usually lowers the time needed. Special projects can be involved depending on whether or not the purchase is of a public or private business. In such instances I might contract another Accountant for his or her unique industry knowledge etc. No one Accountant knows all. A little humility is helpful.
If you have a business purchase or investment in play, make sure to conduct a reasonable amount of due diligence and satisfy your questions. Try to avoid being enamored with the target and look don't listen. The documentation is where you find the operational value and of course it helps determine if the price being paid is fair. Due Diligence can lead to a renegotiated price in view of findings or even nix the deal entirely. No business is perfect and all have a few blemishes. But in general, uncovering them before purchasing is just good business sense.
If you have any questions or need assistance regarding your due diligence call me. If I am not well suited to your situation, I will volunteer that and can make other recommendations that are tried and true. Expect to pay for professional due diligence help but it can save tens of thousands and help prevent walking into land mines.
Best of Luck.
Donn Marier
DM -Your Own CFO