The beginner's guide to due diligence

By: Clive Hyman

Date: 7 June 2017

The beginner's guide to due diligenceIf you are thinking of expanding by buying a business, then you need to do your due diligence. Likewise, if someone is thinking of buying your business, they will want to do their due diligence on you.

So, what is due diligence and what does it involve?

1. Understanding

Understand what you are buying. Meet with the owners and management who understand the business and also those who keep and prepare the accounts.

2. People

You must find out about the management team. What has it achieved to date? Do the key managers and directors have a good reputation? Talk to people who know members of the team well.

3. Heads of agreement

Get "heads of agreement" as soon as possible. This gives you a reference point. All deals will be subject to a Sale and Purchase Agreement (SPA) and should provide a mechanism to deal with adjusting the price, should a fact turn out to be slightly different from what is recorded in the accounting records.

4. Money

It is essential to arrange conversations with banks or equity providers to ensure the capital/debt or other finance will be there when you need it.

It is frighteningly common for potential buyers not to have offers that are subject to due diligence. When you want to close the deal, financing must be in place.

5. Start-ups

If the business is a start-up, you won't be able to see a track record. Be realistic and work out how quickly the enterprise can make money. Start-ups are a risky purchase - consider waiting until they've proved sales can be made.

6. Track record

For an existing business you must pay attention to the results to date and the trajectory they show. Understand the cost base to establish how any cash invested might be used to drive the business forward. Comparing the current results to forecasts and budgets is a useful exercise; this can help you understand the reasons for any deviations.

7. Forecasts, budgets and reality

If a company has a budget and a forecast you can assess whether a management team is likely to meet its goals. The forecast needs to take account of the plans for the business post-deal – so you can again assess the financing requirements.

The comparison between the forecast, the reality and the budgets is crucial. You need to understand whether the team is conservative or living in fantasy land.

8. The bottom line

EBITDA is Earnings Before Interest Tax Depreciation and Amortisation. The EBITDA will give you the true recurring profitability underlying all the other figures. It offers a "clean" figure to use for comparisons. The profitability of the business is important to understand to help you determine what you should pay.

9. What next?

Appoint someone to head up and drive the deal. Communication is essential. Far too often I hear: "they knew I was interested; why didn't they contact me?"

Time spent on due diligence will help identify issues and allow you to make an informed decision about the deal and the price.

Sponsored post. Copyright © 2017 Clive Hyman, founder of Hyman Capital Services.

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