If you plan to buy a business, one of the first things you will need to do is your due diligence.
However, many people don't know much about due diligence, which can be confusing. This article discusses due diligence for either buying or selling a business.
The main question we will answer is what happens after a due diligence period. However, we first need to determine what due diligence is, why it's important, how it works, etc.
When you are selling a business, due diligence is the process of investigating a potential investment or investor.
Usually, due diligence begins after both the seller and the buyer have signed an initial agreement. The primary purpose of due diligence is to verify the accuracy of the information that the seller has presented.
Buyers should also perform due diligence, but it's much more common for sellers to do so.
First, however, buyers should confirm that the business is receiving as much cash flow as the seller indicates.
For the seller, due diligence is essential to verify the buyer's intentions, their background in the industry, if they have good credit, and enough assets to complete the transaction that has been agreed upon.
What Factors are Examined?
Before discussing what happens after the due diligence process, we must understand what the process entails. The complexity of the due diligence process depends on the size and scale of the business.
Of course, the factors incorporated into the due diligence process will depend on the type of business.
For instance, there are things to know about a manufacturing business that you won't need to know about an online business. Therefore, each due diligence process is specific to the business and the parties involved.
As a buyer, your goal should be to ask the most relevant questions of the seller but don't overwhelm them. A seller should ensure that the buyer can go through with the purchase as agreed upon.
However, we can list the basic things most due diligence processes should account for.
• Condition of the assets
• Customer contracts
• Accounts payable and accounts receivable aging reports
• Real estate leases
• Vehicle and trailer titles
• Customer demographic and concentration information
• Equipment lists
• UCC filings
• Incorporation and registration documents
• Three years of income statements
• Three years of tax returns
• A recent balance sheet
You should also be aware that there are two forms of diligence. The first is financial due diligence, which analyzes the target company's financial records and financial well-being. This will include revenue, growth trends, profit, long and short-term debts, income statements, and balance sheets.
Then, there is legal due diligence to verify the company's legal structure. Legal due diligence may include customer abuse of the seller, the customer base, contracts, inventories, and warranties.
How Long Does the Due Diligence Process Take?
Now, the length of the process depends on the size of the business and the buyer and the seller. Moreover, the duration will depend on how complex the deal is and how much money will be exchanged.
One important thing to note is that no law says how long the due diligence period should last; it depends on the two parties. A due diligence period can be negotiated by both sides. Most buyers will arrange for a much longer due diligence period, and sellers will often try to shorten the process.
Generally speaking, you can expect the average due diligence process to last between 45 and 180 days. For small companies, somewhere between 45 and 90 days is relatively standard.
However, for larger companies such as strategic buyers, or a private equity group investing in a business that generates between $1 million and 25 million per year, the process usually lasts between 60 to 180 days; the larger the company being purchased, the more complex the deal, the longer the process will last.
What Happens After the Due Diligence Period?
Now that we know what due diligence is, how long it lasts, and how it works, we can discuss what happens after the process is over. First, there will usually be an LOI, letter of intent, or the offer.
This letter will include the due diligence clause, which sets out the terms for all parties. This will specify how long due diligence lasts and what will happen after. This is known as a due diligence contingency.
If either party is not happy with what they find during the due diligence period, they may withdraw from the contract. Usually, there will also be a clause that any deposits made can be returned if the buyer or seller backs out before the end of the due diligence period.
When the due diligence process ends, three main things may happen. Either the buyer or the seller, depending on the contract, will have three options. Let's look at these three options.
The Deal Goes Ahead as Planned
If everything goes to plan, the first thing is that everything continues forward, and the deal is closed. If the parties performing the due diligence process are satisfied with all of the findings once the due diligence period is over, the deal should go through.
The Buyer or Seller Backs Out of the Transaction
Remember that the documents outlining the due diligence process will include any contingencies set by the parties doing the due diligence.
These contingencies will state that, for whatever reason, the buyer or seller may back out of the transaction if they find something they do not like.
Some due diligence documents may say that backing out of the transaction is not doable once the due diligence process is over, but how this works will depend on the entities and what has been agreed upon.
Re-Trading or Renegotiation Takes Place
The other thing that may happen after the due diligence period is that renegotiation or re-trading occurs if the party performing due diligence finds something that will affect the purchasing or selling price. Often the ability to renegotiate terms, specifically the price, will be stipulated
The due diligence documents will state exactly when, how, and why renegotiations can occur after the due diligence process. Once renegotiations have taken place, both parties must then agree on the terms for the transaction. If both parties do not agree on the terms, the transaction may fall through.
If money is being borrowed for the purchase, such as from a bank, there will also be a lender review after the due diligence period. It will generally take a closer look at the creditworthiness of the buyer.
If money is being borrowed, the lender wants to know that they will get their money back. If a lender does not approve, they may not approve the loan, in which case the transaction will not go through.
Due Diligence in Business – The Bottom Line
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