This article are provided for information purposes only, and are not intended as legal advice.


Should you do your own due diligence when buying a business?

October 26th, 2009

You are trying to buy a business and want to keep as much cash as possible for the business.  As a result, you want to avoid using professional advisers in order to save money.  You want to conduct your own due diligence.  Is that a smart move?

 

If you purchase a business and did not notice something material in your due diligence, did you end up buying a business which you should have walked away?  Are you experienced in knowing what to look for?  Remember, everything that the sellers shows you is probably there, the main purpose of due diligence is to try to find out something that the seller of the business did not tell you.  If you buy the shares of a business, you are also buying all the liabilities of the business, even those that were not disclosed prior to closing the sale of the business. 

 

Now that you have closed the purchase of the business, you feel confident that the old owner has signed a guarantee and will reimburse you for the additional liabilities.  Try to find the old owner?  If there is a tax liability relating to the years prior to your ownership, do you have to defend the company?  If you just pay the taxes, then can the old owner state that you did not try to minimize the tax liability?  Whose job is it to try to reduce the liability?  When does the old owner pay?  What happens if the old owner has moved and you can’t find them?  Do you need to sue them to get your money?  If that is the case, it could be years and you will incur additional costs to try to recover the costs you paid to a third party.

 

Many years ago,  I did the due diligence of a franchise for sale.  I discovered a fraud, sales were significantly overstated and the company was not making money as the internal financial statements indicated, they in fact were hemorrhaging.  My client walked from the investment during the due diligence process.  Someone else decided to buy the business and they did not discover the fraud in their due diligence.  I do not know if they did they did their own due diligence but I understand that the business closed several months after they purchased the business.  I saw another case where they believed the projections of the owner even though the retail location was losing money consistently.  They wanted to save costs so they did their own due diligence and six months later they realized that they had lost almost 100% of their investment, they made the wrong decision.

 

You may be lucky and get away with nothing wrong, but if you purchased something you should not have and that would have been discovered in due diligence, a few thousand dollars in fees to an advisor is far cheaper than losing hundreds of thousands of dollars on an investment which goes bankrupt.


Filed under: Due diligence — Gary Landa @ 10:05 am


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