Due diligence – the importance of doing the research before you purchase

Welcome to 2020 – a new year and a new decade. Many of you may be considering a change, buying a business could be an option.

There are many good reasons to buy a business; from providing employment to yourself and others, to investing in an industry and getting a return on your investment. Whatever the reason for buying a business, doing some research before signing on the dotted line is an absolute must! If you are considering purchasing an existing business, you will want to ensure you engage an accountant to assist you in reviewing the offer and completing some due diligence. Due diligence is simply the process of checking out a business to make sure the information provided is reliable and there is nothing untoward that could come as an unwelcome surprise to you as the new owner. Although the due diligence process will vary between businesses depending on the areas of risk, some key areas you will want to consider are the purchase price, funding the acquisition, employees, internal controls and structuring.

The Value of the Business

Don’t pay more than what the business is worth to you. It is important to understand what the business return will be, the risk in the ownership change, upcoming changes or challenges in the industry, and how all of this will affect future profits. You will need to fund the purchase price, so you want to ensure you are getting bang for your buck to obtain a decent return to meet capital repayments. It is important to pay attention to business lending repayment timeframes and what this means regarding required profits.

Employees

Does the business you are buying have employees? Will you retain these employees when you take over? Is the current resource adequate? You may not need all the current staffing resources, but you will want to retain key employees. Removing the wrong people could impact the ongoing trading results, hitting the bottom line and affecting your return. You will need new contracts for all staff members, and a payroll system is highly recommended to assist in accurate PAYE and annual leave calculations.

Internal Processes

Having well-documented processes makes it easy for a new owner to step into the business and take over. If the business is heavily reliant on information retained in the heads of exiting staff or owners, you as the purchaser should have less confidence in the ongoing trading. Examples of documentation you will want to review are the operations manual, leases, and contracts with main suppliers and customers.

Leases

Leases of business premises and key operational equipment should also be reviewed to determine how long these are for, what renewal periods are available and what end of lease obligations exist i.e. reinstatement. It is important to confirm also that any leases required for the business to continue operating can be transferred to you as the new owner.

Business Structure

Before you purchase a business consider what structure this business will trade-in. Trading in a company means you need to determine how many shares there will be, and who will own them. There are also tax considerations as to the most appropriate structure, now and in the future. If you have a family home, you will want to protect that asset from trading risk. Having an appropriate business structure prior to the transfer of ownership will protect your current wealth while providing for business growth and succession planning.

Cashflow and Balance Sheet Forecasting

Obtaining capital investment often means you need to show you can meet your capital repayments, and that the business will be profitable. Forecasting assists with this process, as well as helping you determine where you can expect to experience cashflow fluctuations. This information is valuable to ensure adequate facilities are in place for low cashflow periods, and that you time further capital purchases appropriately. Working in business in New Zealand is largely about who you know, and with Hayes Knight, our contacts are your contacts. A close working relationship with people you can trust will make all the difference to your experience as a business owner. If you are interested in purchasing a business, meet with us before you sign – we can help smooth the process, and ensure the purchase is the right one for you.