Carrying out a full and thorough due diligence process when buying a business out of administration is essential. Due diligence is an important part of any business acquisition, but when a distressed business is involved, this step is even more crucial.
Here, we take you through the reasons why due diligence is so important and the kinds of issues or questions that your due diligence process needs to answer.
The ability to carry out a thorough due diligence investigation in a short period of time is a prerequisite for buying distressed businesses from administrators.
Why is due diligence important?
You have a better chance of success in buying a business if you complete a due diligence process. When looking at buying a business in administration, due diligence allows you to take a detailed look at the various aspects of the target business, including its finances and liabilities, such as the level of debt it is in. you will also be able to review aspects like its staff, its marketing activities, its management, its assets and, ultimately, why it failed in the first place.
Put simply, a thorough due diligence process will allow you, as the potential buyer of a distressed business, to conclude whether it is saveable.
When is due diligence carried out?
Due diligence usually takes place after an offer is accepted in a business acquisition deal, but before any contracts have been signed or exchanged. It could be the case that, when buying a business from administrators, the time-frame allowed for due diligence is more narrow than in a regular sale. The ability to carry out a thorough due diligence investigation in a short period of time is a prerequisite for buying distressed businesses from administrators.
Areas to examine during the due diligence process
Reviewing business financials
Looking into the business’s finances over the past years will help to establish if it has any major outstanding liabilities that will be passed to a new owner should an acquisition take place. Look out for issues like product liability claims or adverse legal judgments. Tax liabilities also need to be examined.
Establishing where the business was making money and where it was losing money will help you, as the potential buyer, to establish which were its stronger areas of business, allowing you to focus on these areas should you decide to acquire the business and turn it around.
Your financial due diligence should involve close examination of the following documents:
- Financial statements
- Balance sheets
- cash flow
- Bank account statements
- Profit forecasts
- Tax returns
Assets, both physical and intellectual
Establishing whether the distressed business has assets, such as patents, trademarks, copyrights, machinery, tools, premises and vehicles is essential.
Management and staff
Are the staff remaining with the business as part of a deal and to what level are they experienced in running the business? Employees can be an asset and can help buyers to turn around a business in distress, particularly if the problems experienced by the business were caused by poor management of these staff, or by unrelated issues.
Finding out whether management will be staying on in the event of a sale is also crucial, while establishing whether management has a role to play in the demise of the business in the first place will be helpful.
Counter to that is the situation where the management were a valuable asset in the struggling business. In this scenario, establishing whether they will remain with the business after a sale is as important as without them, turning the business around could be much more difficult.
A thorough legal due diligence process is advisable when buying a business out of administration, as turning around a business that has pending legal issues can be more challenging. The costs involved in dealing with unresolved litigation can be insurmountable.
The legal due diligence process is perhaps the most important area of due diligence when taking over a distressed business. Try to get hold of the following documents to help you establish the legal status of the business:
- Supplier contracts
- Customer contracts
- Incorporation documents
- Employee contracts
- Documents proving ownership of physical assets
- Lease or purchase documents for land or premises
- Documents showing details of any past or pending litigation
In conclusion, carrying out due diligence is important for you, as a potential buyer of a distressed business. The process will allow you to ensure that the price you’re paying is a fair representation of the business’s value. It will also help you to identify any hidden issues, which could impede your attempts to turn the business around following an acquisition.
Bringing in outside help, such as a lawyer who has experience in mergers and acquisitions, can increase the effectiveness of your due diligence. The process isn’t cheap but get getting it right might mean the difference between buying a business ripe for turning around and buying a business that is over-laden with debt and pending litigation, or whose excellent management has abandoned ship, for example.
If you unearth unexpected problems during your due diligence, this doesn’t always mean the end for the opportunity. It may simply allow you to build these challenged into the negotiation process. You may be able to ask for certain assurances or add clauses into the paperwork to cover your back as the buyer.
Take as much time as you have and use experts when necessary to ensure you do a thorough job of due diligence when buying a business out of administration and you will save yourself time, money and a whole lot of stress in the long-run.