Doing Your Due Diligence – Or Else!
“Due diligence” is the process by which you make sure you are getting the benefit of your bargain in a contract. In its most simplified form, it’s like inspecting the goods before you take them to the cash register. Or, if you’re the seller, making sure that the $100 bill the customer paid with isn’t counterfeit. Because once everyone walks away from the transaction, you’re stuck with what you’ve got.
It’s a bit more complicated in an asset purchase or stock sale. If you are buying a business you have to be sure that the business is as good as promised, and that it is sustainable without the current owner before you plunk down your life savings and/or a personal guaranty on a promissory note. If you are selling your business, you want to make sure that the buyer’s due diligence is thorough. If you are holding the promissory note (or guaranteeing a promissory note for the buyer), you have to be certain that the buyer is going to repay the note.
You can’t simply rely on a commissioned business broker. This is one time that you have to hire a lawyer who represents your business’s best interests.
We see all too often what happens when either buyer or seller fails to conduct proper due diligence. The buyer sues the seller for failing to make material disclosures about the financial condition of the business (or other material matters). The seller countersues the buyer for failing to make payments as promised. We end up at the mediator’s office trying to settle the whole matter out of court, and everybody loses but the lawyers.
So how exactly do you prevent litigation when a business sells? Start by knowing with whom you are dealing. Spend some time with the other party to the transaction. Make sure that you are on the same page. Know what each other expects out of the deal.
Next, evaluate the financial picture. Look at the other party’s tax returns and bank statements for at least 2 or 3 years. Look at the business’s balance sheet, profit & loss, accounts payable, and accounts receivable. Look at the buyer’s credit report.
Then look at the assets. Did you buy the seller’s contracts with existing customers? If so, are the contracts assignable? Are you getting what you paid for? Inspect any leased premises, and make sure you get a copy of the current lease. Inspect any furniture, fixtures, and equipment you are buying, too.
Finally, make sure that any business entities are properly formed, that all the corporate documents are in order, and that they are in good standing with the State. Make sure that the parties are authorized to enter into the transaction.
Most of our clients prefer to do some of their own due diligence, but almost all ask that we review any contracts, corporate documents, and closing documents prior to closing the sale.
Looking to buy or sell an existing business? Talk to one of our attorneys at 407-792-0790.