Due Diligence When Buying a Business 

If you are thinking of investing money in someone’s company to make it your own, the journey ahead isn’t as straightforward as you might expect. Buying a business isn’t like walking into a grocery store and buying a bottle of milk. Before you actually make the purchase and become the new owner, you will need to analyze the business's performance in-depth. This includes performing due diligence.  

Without due diligence, you’re essentially buying a pig in a poke as there is no knowing whether or not the purchase is a sound investment. After all, you wouldn’t want to end up buying a business that isn’t as valuable as you were led to believe or a business that’s embroiled in lawsuits, creditors' claims, or in bad standing with the Internal Revenue Service (IRS).  

Conducting due diligence allows you to eliminate uncertainty and reveal hidden risks when purchasing a business. And our attorneys at Caleb Bland Law, PLLC, can help you perform due diligence the right way so that you know exactly what you’re getting into.  

What Is Due Diligence?

Due diligence is a thorough investigation of a business that you plan to acquire. It involves reviewing various aspects like financial records, legal obligations, and operational practices to gain a complete understanding of the business's current state and future potential. Think of it as a comprehensive health check for the business you’re looking to buy. You wouldn’t want to end up buying a business that doesn’t live up to the promises made by the seller, would you?  

According to the U.S. Department of State, due diligence involves looking into the risk of adverse impacts as a result of operating a business and, based on that information, devising a plan to address the risks.  

The purpose of due diligence is to uncover any hidden liabilities, verify the seller's claims, and ensure there are no unpleasant surprises after the purchase. While this precautionary step may seem daunting, you shouldn’t skip it. Performing due diligence is essential to making an informed decision and safeguarding your investment. 

By conducting due diligence, you’re essentially protecting your interests. You can identify any red flags, negotiate better terms, or even decide to walk away from the deal if necessary. It provides a clear picture of what you’re getting into and helps you avoid costly mistakes. 

Types of Due Diligence

There are several types of due diligence that you need to be aware of when buying a business. Each type focuses on a different aspect of the business and provides valuable insights to help you make an informed decision: 

• Financial due diligence 

• Legal due diligence 

• Operational due diligence 

• Tax due diligence 

• Environmental due diligence 

• Human resources (HR) due diligence 

• Marketing due diligence 

• IT due diligence 

• Strategic due diligence 

Each type of due diligence helps form a comprehensive view of the business. By examining all these areas, you can get a full understanding of the business’s strengths, weaknesses, opportunities, and threats. 

When Should Due Diligence Take Place?

Due diligence should begin as soon as you express serious interest in purchasing a business. Ideally, this process starts after you’ve signed a letter of intent (LOI) but before you finalize the purchase agreement. The LOI outlines the basic terms and conditions of the potential deal, providing a framework for the due diligence process. 

Starting due diligence early allows you to uncover any potential issues before you’re contractually obligated to complete the purchase. It gives you the leverage to negotiate better terms or adjust your offer based on the findings. The earlier you start, the more time you have to address any concerns and make an informed decision. If you already have an obligation to finalize the purchase, due diligence doesn’t make much sense at that point.  

It’s also important to keep the seller informed about your due diligence timeline and requirements. Clear communication ensures that both parties are on the same page and helps facilitate a smoother process.  

The Risks of Not Performing Due Diligence When Buying a Business

Skipping due diligence when buying a business can lead to avoidable risks and potential losses. Without a thorough investigation, you may end up with a business full of hidden liabilities, overpaying for the business, or facing unexpected operational challenges after the sale is finalized.  

One of the biggest risks is the potential for financial loss. Without proper financial due diligence, you may not uncover issues like inflated revenue figures, undisclosed debts, or unsustainable profit margins. All these factors could directly impact the business’s value and your return on investment. 

Legal risks are another major concern. Without legal due diligence, you might miss out on discovering pending lawsuits, regulatory compliance issues, or intellectual property disputes. These legal challenges can not only result in financial losses but also damage the business’s reputation. 

Operational risks can also arise if you don’t thoroughly investigate the day-to-day operations of the business. You may encounter issues like inefficient processes, outdated technology, or poor employee morale, which can affect the business’s overall performance and growth potential. 

What to Ask for During Due Diligence if You’re Buying a Business?

When conducting due diligence, you need to know what information and documents to request to make sure that nothing gets overlooked. Below are some suggestions to get you started.  

Financial statements: 

• Balance sheets 

• Income statements 

• Cash flow statements 

Tax returns:  

• Federal and state tax returns for the past three years 

• Legal Documents 

• Copies of all contracts and agreements 

• Details of any ongoing or past litigation 

Operational information: 

• Employee records and contracts 

• Customer and supplier lists 

• Inventory details 

Intellectual property: 

• Patents, trademarks, and copyrights 

• Details of any IP disputes 

Regulatory compliance:  

• Permits and licenses 

• Environmental compliance records 

IT systems:  

• Details of IT infrastructure and software 

• Data security measures 

Requesting these documents and information will present you with a comprehensive view of the business and help you identify any potential red flags. Make sure to review each item thoroughly and, if necessary, seek the assistance of an attorney. The duration of the due diligence period can vary depending on the size of the business and the availability of the above-mentioned documents and information. Typically, it lasts between 30 to 90 days, but it can be shorter or longer based on the specific circumstances of the deal. 

Need Help With Due Diligence? Get in Touch Now

While buying a business is an exciting endeavor, it’s also a risky one. If you want to make sure you are making the right purchase free of hidden issues, you will have to conduct due diligence. And our team at Caleb Bland Law, PLLC, can help you with due diligence and other aspects of buying a business. With an office in Elizabethtown, Kentucky, we also serve clients in other parts of the state, including Hardin County, Grayson County, Meade County, Breckinridge County, and others. Contact us today for a free consultation to discuss how we can help with your business law needs.