Due diligence: A critical step in buying a business

A critical step in buying a business, due diligence is done to support the terms of sale (e.g., purchase price may be revised to reflect points discovered). A long, intensive process, due diligence prepares you to negotiate effectively and make an informed decision.

Due diligence is a critical step in buying a business. You've already probably submitted a letter of intention, and if the letter is accepted by the seller, you'll embark on the second step of the process, a detailed audit and investigation of the company's business.

What to audit

Due diligence focuses on many aspects. Everything must be investigated, and not just on an accounting and legal level. You'll have to pass all the seller's claims through a fine toothed comb. You'll do this on the basis of thorough accounting standards and careful legal analysis. You'll also have to evaluate out the quality and value of products sold, the company's relationship with employees, suppliers, main clients, etc.

Following are the primary areas on which due diligence is required and a key element to consider for each. The list isn't exhaustive and some areas may vary from one company to another depending on the company's scope of activity.

• Financial results

  It's been said that numbers talk, but ratios holler! Pay attention to the relationships between trends, or ratios. That sales are increasing is fine. But margins must follow or increase even faster.

• Taxation

  Income tax, tax and deductions at source must be up to date. Don't forget to determine the share of pending government remittances and reimbursements for periods that precede the transaction.

• Cash management, short-term loans and lenders

  Look at financial and banking agreements to learn about all the securities or guarantees involved as well as assess the business's relationship with its financial institution.

• Operating funds

  See if the company's operating funds are managed properly. This will tell you if the company is able to meet its short-term financial obligations.

• Assets

  Pay special attention to sudden and unexplained variations to client accounts (receivables) in terms of sales. This could point to a decline in activity.

• Liabilities

  Question any changes to supplier accounts (payables). Assess the company's relationship with suppliers and their reaction to a potential change of control of the company.

• Inventories

  A list will show you how well the company manages inventory control. You'll need to reconcile any major difference between the book value, real value and estimated value by creditors.

• Finances, long-term loans and creditors

  Check financing agreements carefully. Meet with long-term creditors to evaluate their willingness to continue financing assets.

• Orders

  Question any large swings. Analyze product sold, clients, salespersons, etc. Does the company rely on a single star product, client or client group? What is each salesperson's current and historical share of orders? A lion's share of sales gives a salesperson undeniable power in the short-term.

• Human resources, managers, working conditions, vacation time and pensions

  Do employment contracts, including pay and benefits, comply with applicable laws? Are there any unresolved human or legal issues?

• Capital, property, organization

  Is the company in good standing order? Are all documents, policies, records, certifications, accounts, values, agreements, procedures, etc., in order?

• Market, competition, clientele

  Where does the company stand in its market? What are its strengths and weaknesses in the market? How is it perceived by clients and the competition? What are its marketing practices?

Key benefits

Due diligence is a long, intensive process, but one from which you'll reap many benefits. You'll have a better understanding of your future company's managers and employees. You'll have an opportunity to meet and talk to employees, managers and key employees and be able to assess their knowledge of operations, ability to handle stress, loyalty, attention to detail, etc. You'll know your company in and out and be in a position to clearly identify its strengths and weaknesses, what has to be corrected and what you can count on.

Feel free to consult with your Desjardins account manager who, based on your needs, will refer to one of our many experts.