Home > Updates > Buying a business? How to make sure you get what you pay for
Buying a business will often be the largest investment that a person will make, and unlike property, the purchase will involve a high degree of risk. When looking to purchase a business, it is therefore important to undertake due diligence to ensure you are getting what you pay for. Engaging the assistance of a Chartered Accountant and lawyer ensure there are no hidden surprises.
Areas typically reviewed in a due diligence project include:
Prior year financial statements and year to date management reports will often show trends which should be investigated. Attention should be given to ensure there are no warning signs such as decreasing sales or margins, or significant increases in overheads. Data should be compared to industry benchmarks where possible.
GST, PAYE and income tax returns should be reviewed to ensure what is being reported to Inland Revenue matches the financial statements. GST returns can be used to verify sales figures, PAYE to verify wage costs and income tax returns to verify the reported profit in the financial statements.
Key customers should be analysed to establish if there is a risk of over-reliance on one or two customers. Trade terms and whether contracts are in place also need to be considered. The aging of the accounts receivable will show how well the business is collecting payments; poor aging will put a strain on cashflow.
Supplier relationships are often an important part of the success of a business. Much like customers, the supplier list should be checked for key reliance, contracts and aging.
If the business has employees, it should be established what role each plays in the business and whether they will continue following the sale of the business. Do the employees have contracts and are the current wage rates as expected? Usually there are no requirements to retain all the staff, so you can determine who you retain.
The fixed asset schedule should be reviewed to ensure the value placed on items are accurate. You should also ensure that all the assets being purchased are required for the continued running of the business. For industries with large plant and equipment, service records should be sighted to ensure the assets are well maintained.
A stocktake should be performed immediately prior to takeover to ensure that you are paying for the correct level of stock. Care should be taken to make sure that you are not paying for obsolete stock.
Are the premises that the business trades from an integral part of the business? If so, it should be ensured that the lease agreement can be reassigned and that there is a reasonable term remaining. This will also detail rent reviews, which should be considered.
Ensure the current owner has documented critical business processes such as inventory ordering and management, customer sales, debtor management, wages, accounts payable, monthly management accounts, and the IT system, to ensure a seamless transition.
Sale and Purchase Agreement
It is prudent to engage an experienced lawyer ensure there are no hidden surprises. Will the transaction be an asset and goodwill sale or a share sale? What risks will you adopt as the purchaser? Will the transaction meet the criteria for zero-rating of GST? The split of fixed assets, stock and goodwill in the purchase price will also have tax implications. The new purchase price allocation rules will need to be considered.
It is important to have the correct structure in place prior to purchase as it can be difficult to change once trading has commenced. Getting the right advice surrounding structure will help to minimise the risk of being in business and ensure that you remain as tax efficient as possible.
With so many things to consider, and often large sums of money at stake, it is important that you get the correct advice prior to finalising any purchase. This will give you confidence in what you are buying and give yourself the best chance of success. Engaging a trusted and experienced Chartered Accountant and lawyer will assist in the process.