When buying a business, it's important to understand the due diligence process.
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In this article, I answer a few questions about due diligence that are frequently asked by business buyers and business sellers.
When Does Due Diligence Occur in the Business Buying Process?
Due diligence is generally conducted after a contingent agreement or non-binding letter of intent is in place and earnest money has been provided.
Some buyers think they can conduct detailed due diligence prior to their expressing serious interest in the business, but this is not the case.
If you think about it, it makes sense that due diligence occurs later in the business buying process.
After all, conducting due diligence before a letter of intent has been signed can raise issues of confidentiality. The business seller does not want to disclose confidential information to anybody who asks.
In addition, due diligence costs money and consumes time. Finally, it can disrupt the seller's business operations.
For these reasons, buyer due diligence takes place in the advanced stages of buying a business.
What Are the Goals of Due Diligence in the Business Buying Process?
The objective of due diligence is to ensure the buyer obtains all the material facts required to make a fully informed assessment of the company while not unduly disrupting the seller's business.
The process involves verifying that the financial and operational information provided is accurate within a reasonable degree of tolerance to the buyer.
Does a Seller Have to Refund Earnest Money If a Buyer Finds Problems During Due Dligence?
Earnest money is refunded if one or more contingencies cited are not met, or if due diligence uncovers material facts in dispute with the prior representations on which an offer was based.
How Should a Business Buyer Approach Due Diligence?
While it is imperative to develop a list of items required for due diligence, it is equally important to have a due diligence plan and a process for completing due diligence within a reasonable timeframe.
Buyers should remember that no business is perfect. It is not uncommon for buyers to find some inconsistencies or anomalies and these should be questioned and understood.
If the information turns out to be structural or material then you may consider either canceling the deal or renegotiating based on the new facts.
However, be careful not to over-react and assume that any deviation is a deal-killer.
In our experience, differences can often be explained with thoughtful communication between all the parties.
What Questions Are Asked During Due Diligence?
The questions asked during due diligence are not the same for every deal.
Rather, the lists of due diligence items are dependent on the characteristics of the deal in question. They will be based on the type, size and complexity of the business being purchased.
Example due diligence lists can be easily acquired from your attorney or your business broker.