The Importance of Due Diligence when Buying an Existing Business

Introduction

When expanding a business, entering a new market or undertaking a new venture, you may consider buying an existing business. In deciding what avenue to pursue, it is worth considering the advantages and disadvantages associated with purchasing an existing business in comparison to starting your own.

As such, before purchasing an existing business it is important to carry out due diligence to assess the value, risks and potential of the business so that you are able to make an informed decision. In undertaking this process, an experienced lawyer can greatly help you navigate the legal complexities.

Advantages and Disadvantages

Buying an established small business offers several advantages in comparison to starting your own business. 

First and foremost, you will usually inherit an existing customer base, which can provide immediate cash flow and revenue. This can save you the time and effort that is required to build a customer base from scratch.

Additionally, an established business often has existing relationships with suppliers, distributors, and other stakeholders, providing you with a head start in identifying key resources and entering the market. Brand recognition and goodwill associated with an existing business can also help you establish credibility and reach in the industry.

On the other hand, starting your own business allows for greater control and customisation. You can shape the business according to your vision and preferences without inheriting any existing issues or limitations.

Starting from scratch also enables you to choose the location, design the infrastructure, and hire the team that aligns with your strategic objectives, rather than inheriting from the existing business. However, building a new business requires substantial time and resources, and success is not guaranteed in the early stages.

Due Diligence when Buying a Small Business

For an existing business, due diligence typically refers to the comprehensive investigation and analysis of the target business to assess its value, risks, and potential for growth. It encompasses investigating the financial, legal, operational, and human resources of the proposed business.

Financial and Legal Due Diligence

Financial due diligence involves scrutinising the proposed business’ financial statements, tax records, cash flow, and debt obligations. This helps you evaluate the accuracy and reliability of the financial information provided by the seller, assess the business’s profitability and financial health, and identify any potential financial risks or liabilities. This can also have an impact on how much you are willing to spend on purchasing the business.

Legal due diligence focuses on examining the legal documents, contracts, licences, permits, and regulatory compliance. It ensures that the business has clear title to its assets, that there are no legal disputes or pending litigation that may affect its operations, and that it complies with applicable laws and regulations.

Taking over existing agreements forms another aspect of the due diligence process. You will need to review contracts with customers, suppliers, landlords, and other key stakeholders to assess their terms, obligations, and potential risks or liabilities. This ensures that you are fully aware of the existing contractual relationships and can effectively manage them after the acquisition of the business.

A lawyer can assist with various legal aspects of due diligence, for example, assessing the business’s intellectual property rights, reviewing contract terms and conditions, and investigating obligations under existing agreements that will be assigned to you as the new owner. Accountants can also help with financial due diligence by analysing and assessing the accuracy of financial information and identifying potential financial risks or liabilities.

Operational Due Diligence

Operational due diligence involves assessing the business’ operational processes, systems, and infrastructure. You may need to evaluate its supply chain, production capabilities, technology, and any intellectual property rights. This helps you understand the efficiency and effectiveness of operations and identify any operational risks or inefficiencies.

Operational due diligence may also involve an evaluation of the business’s human resources. This might encompass reviewing employment contracts, assessing employee benefits and compensation packages, and understanding any potential labour issues or legal obligations. This helps assess the quality and suitability of the existing workforce and plan for any necessary changes or restructuring. A lawyer can provide guidance on employment matters, ensuring compliance with employment laws, and assist with the transfer of employees or restructuring, if necessary.

Conclusion

Regardless of whether you choose to buy an established business or start your own, due diligence is a crucial step in the process. As such it is essential that you obtain competent and independent legal and financial advice, which can help minimise your risk and enable you to make an informed decision about your proposed venture.

Contracts Small Business

Growing your business – understanding equipment leases

If you are starting or expanding a business, you would be aware that equipment can represent a large cost. Although in an ideal world, you would be able to meet that cost outright, the reality is that you may not have the capital to meet the costs of all the...

Read more

Employment

Employees v Contractors: What is best for you and your business?

It is more important than ever to ensure that the relationship between you and your employees or your contractors is comprehensively covered. In 2022 alone, there have been two High Court cases delivering judgements on the importance of declaring an individual’s employment status under written contracts and agreements.   What...

Read more