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
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
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?
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
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
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