Due Diligence

By the end of the due diligence process, you should know about the overall financial health of the business, its prospects, competitors and the market.

Your solicitor and accountant can help, but you'll also need to investigate the business yourself. If the vendor is reluctant to provide any financial information, then warning bells should be going off.

Check financial statements
Ask yourself if the business can generate enough money to provide you with a reasonable income and make a profit. You'll need to view balance sheets, profit-and-loss statements, annual reports and any cash-flow statements of the business for at least the past three years. If the statements aren't audited, you'll need to verify the numbers against independent evidence, such as sales records, invoices, bank statements and loan documents.

You’ll also need to check the financial statements and books since the end of the last financial year to assess the profitability of recent operations and the profitability of the business in the future.

Compare the rate of growth for profit, sales and costs. Ask the existing owner whether there are new or increased costs you should anticipate. Are there any cash flow or debtor problems? Are bills being paid on time? Who are the key creditors? Know the accounts back to front before you buy.

Quick checklist:
.Check profit-and-loss statements
.Check balance sheets
.Check annual reports (if it’s a company)
.Check cash-flow statements
.Get independent evidence of finances

Check tax records
The tax returns of the business should give you an idea of its profitability. You'll need to check income tax returns and assessments from the Australian Tax Office for at least three years and reconcile the business’ taxable income and profits with its financial statements.

You want to be sure that the business’ PAYG (pay-as-you-go income tax), GST and other tax obligations, such as payroll tax, are up to date.

You'll also need to check whether the purchase of the business will be GST free (if you are buying an ongoing business) and how much stamp duty you'll be up for.

Quick checklist:
.Check income tax returns for previous three years
.Check business activity statements (BASs)
.Check payroll tax records (if applicable)
.Check stamp duty records (if applicable)

Check the assets
You’ll need to verify that any plant, equipment, fixtures and fittings are in good working order. You should do a physical inspection of the business premises and possibly seek an independent valuation. You do not want to buy obsolete facilities which can be costly to replace.

Ask for an asset list and check off physical items against it. Do a stocktake to assess the amount of stock on hand and its value as at the settlement date.

Where assets are leased by the business, obtain copies of the leases. Check that assets are insured until settlement of the purchase.

Quick checklist:
.Inspect plant and equipment
.Check asset lists
.Do a stock valuation or stocktake
.Get insurance details

Know your customers and suppliers
Get to know who your customers will be, how loyal they are and which ones are key to your business. Check the customer database (if there is one) and whether their loyalty is locked in through contracts or if future business is guaranteed. Are there any major contracts which are about to expire?

You also need to check who the key suppliers are and if they'll continue to trade with you. Ask about the business’ ability to pay its bills on time and any expected cost increases.

Quick checklist:
.Get a list or database of key customers
.Check sales contracts
.Get details of suppliers

Find out why the owner is selling
Check as early as possible why the owner is selling. If the business is badly managed or run down, the existing owner might be trying to offload it because it isn't making any money or its prospects are poor.

Check how long the owner has operated the business and how long it has been on the market. Have any offers been made and if so, what are they?

Customers, suppliers or nearby traders or competitors can be good sources of information about the business or its problems.

Quick checklist:
.Investigate the reasons
.Ask customers, suppliers, competitors
.Check for hidden problems

Check legal rights and obligations
You’ll need to check whether any government regulations cover the business and whether it has all the relevant permits and licenses which it needs to operate.

Determine your obligations to existing employees, including any leave entitlements or compulsory superannuation payments which need to be made. Check whether workers compensation premiums are up to date.

Ask about the intellectual property of the business and the business name, and whether they are protected through licenses, patents, trademarks and registrations. Will these rights be passed on with the sale?

Examine any agreements binding the business, such as leases, and ask for a copy. Check if there is a right to renew on the lease and if that option is yours to exercise. If there isn’t a right to renew, could you find another suitable location?

If you are buying a company, it’s important to check the Australian Securities and Investments Commission (ASIC) website for company details. The Australian Competition and Consumer Commission (ACCC) website can tell you if the business has been the target of any ACCC enforcement actions. Contact your state or territory consumer affairs agency for any track record of dodgy trading.

You should also check if the trader has ever been taken to court by visiting the Australasian Legal Information Institute (Austlii) website, which lists legal actions from all Australian jurisdictions.

Quick checklist:
.Review government regulations
.Check worker entitlements
.Assess intellectual property
.Check the lease

Check out the competitive landscape
You'll need to know who your competitors are. Check the growth of competitors, assess their strengths and weaknesses and how they threaten your business. Compare profitability, earnings, prices and costs if you can.

You'll also need to assess whether any new competitors are planning to start up, potentially taking away your customers or harming your profitability. The local council will be able to tell you about new developments.

Research the industry in which the business operates and whether it is growing or slowing. Find out about profit margins and industry trends. If the economy is slowing down, ask yourself how this will affect your business prospects.

You can get information from industry associations, government departments and the Australian Bureau of Statistics. You could also seek specialist advice from industry bodies, consultants or business brokers.

Quick checklist:
.Investigate your competitors
.List potential threats
.Research industry trends
.Consider economic factors