Buying a Business: Beyond Legal and Accounting Due Diligence

In a recent presentation to a group of investors interested in entrepreneurship through the acquisition of a small business ($5M - $30M in revenue), Danny Smyth, Owner & President of Lanier Air Products, shared the following thoughts from his purchase of the company.

Once an offer is made and accepted to purchase a business, due diligence begins. Much of this activity focuses on legal and accounting aspects of the company. Smyth advises potential buyers to go beyond the traditional due diligence process and look closely at the following five aspects of the company and its operations.

1.The Role of the Current Owner

The success of most small businesses is the result of a great deal of hard work on the part of the current owner. It is critical to know how “hands on” the owner is and how much of the workload he/she bears on a day-to-day basis. Questions to ask include:

• Is the owner the face of the company to customers and can the trusted relationships he/she has established be transferred without interruption to the new owner?
• Has anyone on the staff been trained as a backup for some of the owner’s duties?
• Does the owner need/want to be involved in the business after the close and what incentive is there to assure a consultative role continues during the transition period.

2.Customer Profiles

Typically, the current owner will supply a list of customers. However, it is not enough to simply have these names. Analysis of the top 20 customers for the past three years will help determine which is strategic to the business and which are transactional.

The customer list needs to include key contacts, with their respective titles and contact information. The key contacts’ roles in the decision-making process should be understood (are they the ones who decide to buy?). It is also important to review the current owner’s process for determining satisfaction with the company’s products and services.

3.Employees

It is universally accepted that an organization chart will not provide vital information about the company’s internal culture. Often, employees have both formal and informal roles within their work environment, and understanding what motivates the various groups within the company is critical.

It is particularly important in a small company to understand how much cross-training has been done and whose absence on any given day can potentially impact overall production. Reviewing turnover rates, including consultants and temporary employees, can provide clues as to employee dedication, motivation responses, and attitudes toward business success.

4.Suppliers

Any operation depends on resources acquired from various suppliers. To understand the contribution to the business, each supplier for the past three years should be analyzed. All existing contracts should be reviewed, particularly as these legal documents could contain “change of ownership” clauses. The service level expected from each should be determined, as well as the pricing history over the course of the relationship.

5.The Strategic Plan

Most businesses have at a few longer-term initiatives in place. It is important to understand their purposes and potential value to the company. Marketing programs, such as the website or customer email programs, should be evaluated based on buyer personas and historical results. Developing a Business Plan that looks out 3-5 years will help guide future decisions. This plan should include an analysis of important indicators such as key market trends, key product line expansion, and geographical expansion. And, most importantly, it should be routinely reviewed and updated.