This is the fourth and final installment in a series that addresses the mistakes commonly made by purchasers of a business. The term “due diligence” refers to the buyer’s evaluation of the targeted business. It involves consideration of operational, personnel, financial, marketing, legal and tax issues. Buyers study various aspects of the business by asking many questions, inspecting what they are buying and reading numerous documents. By performing due diligence, buyers are trying to determine exactly what aspects of the business they are buying and their value. The quality of due diligence varies considerably because some people see what they want to see and hear what they want to hear. Due diligence is not exciting work; in fact, it is often a boring process. Consequently, many buyers skip, shorten, and/or don’t focus on the process and, as a result, they make mistakes. In contrast, smart buyers focus on due diligence because this is where they determine whether they should proceed with the deal or just walk away. Many buyers refuse to walk away no matter what they learn from their due diligence. Putting Due Diligence to Work It is critical that the buyer’s due diligence be tailored to the deal. The due diligence done should vary depending on whether the buyer is purchasing select assets, a division, a subsidiary, or a stand alone entity. Does the target business consist of one location or many? What exactly is the buyer purchasing? An important question a potential buyer should ask is, “What do I need to be successful in this type of business?” The answer will vary depending upon the type of business involved. When a buyer is considering purchasing a business, it should step back and consider the “big picture.” What makes the target business attractive? What does it have that the buyer wants or needs? Is it technology, real estate at a good location, established market position, talented personnel, brand name, or any other critical factor? Once the buyer identifies what it wants, the buyer should then consider other issues such as: Does the seller have good, clear title to the desired assets? Are the desired assets encumbered by liens or security interests? What action must be taken to transfer title to the buyer? Are any approvals for the sale necessary from government officials or third parties? Whatever the purchaser will buy from the seller, the purchaser should inspect it thoroughly. Is the asset in good condition? What is its value? Does the seller actually own the desired asset, simply lease it, or license it? Using Specialists Consider who is qualified to do the due diligence. For example, if the buyer is purchasing large pieces of machinery, does the buyer have the knowledge to determine if the machinery has been well maintained? How much longer can the machinery be used? What is the machinery currently worth? Another buyer is considering buying a jewelry store. He is mesmerized by the sparkling inventory. Are they really diamonds or just cubic zirconium? How would the buyer know? The buyer could hire a gemologist to evaluate the inventory. Consider a seller who has patents the buyer wants. How does the buyer determine whether the patents are any good? The key point is that the due diligence will vary depending upon what is involved. Specialists are often needed to do the due diligence properly. The buyer should admit what he or she does not know and get some help. Adequate due diligence often takes time and requires some expense. Another important question is: how much time and money should a buyer spend on due diligence? To put it another way, how much time and money is the buyer willing to spend on a potential deal and then walk away if it does not see what it wants? My experience is that as the buyer’s investment of time and money increases, the harder it becomes for the buyer to walk away. As the buyer’s investment increases, the commitment to the deal increases. The seller will often take advantage of this to extract concessions from the buyer during contract negotiations. Buyers should keep in mind that the purpose of their due diligence is to provide them with a basis for deciding whether they should close the deal or not. Also, if they elect to go forward, the due diligence should help them determine a fair price to pay. About the Author Dennis Gerschick, Esq., CPA, CFA is the founder and president of Gerschick Business & Investment Counsel, LLC located in Kennesaw, GA. His background as an attorney, CPA, Chartered Financial Analyst, and venture capitalist allows him to view issues and problems from a variety of perspectives. Dennis can be reached at dennis@gerschick.com.