Due Diligence – How’s that Going to Make Me any Money?

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“Make sure you perform your due diligence.” A simple statement that can have tremendously far reaching consequences. I work with people interested in buying a business or selling a business, and this statement can almost appears like “boiler plate” language and get glossed over by the parties involved. What does due diligence have to do with running my business or starting my business? – due diligence is just for buying a business .

Due Diligence – Definition

Due Diligence is a term used for a number of concepts involving either the performance of an investigation of a business or person, or the performance of an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations. A common example of due diligence in various industries is the process through which a potential acquirer evaluates a target company or its assets for acquisition.

Originally the term was limited to public offerings of equity investments, but over time it has come to be associated with investigations of private mergers and acquisitions as well. The term has slowly been adapted for use in other situations (per Wikipedia)

Due diligence is essentially a way of preventing unnecessary harm to either party involved in a transaction. This is a definition when read carefully, can be seen as affecting so many aspects of a business owners life that it can almost become a mantra rather than an after thought.

I’ m ready to get that new office space – Upon completion my due diligence.

I am looking at partnering with my largest customer on a project – After I perform my due diligence.

My business has grown such that I need to select a new accountant and attorney – After I complete necessary due diligence.

I am trying to find a new bank willing to provide the needed Line of Credit and need to perform my due diligence on area banks.

Due Diligence In Business

In business transactions, the due diligence process varies for different types of

Due Diligence

Photo (c) viproperties.com

companies. The relevant areas of concern may include the financial, legal, labor, tax, IT, environment and market/commercial situation of the company. Other areas include intellectual property, real and personal property, insurance and liability coverage, debt instrument review, employee benefits and labor matters, immigration, and international transactions

In Giving: I have used due diligence in investigating charities and organizations I am interested in sharing my hard earned money with. I am a fan of the KIVA organization which provides micro-financing to entrepreneurs in third world countries and allows them to expand their business and or start a new business. I performed my process of due diligence on KIVA www.kiva.org and like the way my money helps others help themselves, like the fact that little of my donations go toward administration fees, and most of the money gets towards the intended recipient. And my daughter and I can research these financially less fortunate entrepreneurs on their website and choose where, and to who our money goes.

You can call it “doing your homework”, “doing my research”, ” checking out the facts surrounding the matter”, or “fact finding”. Whatever you refer to it as, it is most important that the function is performed before most every important decision. And yes, when looking to buy a business or sell a business you must do your due diligence. How much is enough and how much is too much?- That will be dependent upon what you are performing the due diligence on. I have 2 teenage boys (great kids) that tend “jump first look second”. If you are able to reflect on some of your business decisions and find that you have jumped first/looked second- you will know that you have not performed adequate due diligence. Very often the line for enough/not enough is not so clear. For me my gut will tell me if I “feel” I have performed adequate due diligence to make a good decision. Sometimes the result of performing due diligences will result in you not moving ahead with a deal and or transaction. And sometimes the best deal is the deal we did not do.

Legal Disclaimer – Legally, I assume Due Diligence can take on interpretation and meaning that can be thoroughly debated and defined among lawyers. Do you need legal determination of this term? – for that you will need to perform your own due diligence to determine.

Buying an Existing Business vs. Starting my Own Business

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You are an entrepreneur or small business owner or aspiring small business owner and you want a new venture. Do you buy an existing business? Do you start your own business?

Buying an existing business can be safer than starting your own business from start-up. Business startups unfortunately have a fairly high failure rate * Many figures on failure are passed around and it depends on what numbers to believe, but the rate is fairly high (*Statistics I’ve seen from the Small Business Administration (SBA) show that 56% fail within 4 years.)

If you buy an existing business, you’ll have dramatically improved your chances of success. Again, failure/success rates are up for interpretation but your odds are greatly increased. Many businesses for sale have passed the crucial 5 year mark. The owners have run their business successfully for many years. Why would someone want to sell a successful business? There are many real reasons for people wanting to sell a successful business – Retirement, illness, relocation, burnout, etc. There are a lot of good businesses available for sale www.sellabusinessflorida.com that have real value and I have had personal first hand experience with this fact.

Below list reasons and benefits in buying an existing business vs. starting your own business.

Business Startups versus Existing Business Acquisitions

  1. Actual results rather than pro-forma – Sure, business plans and income projections look great on paper…. With an existing business, you already KNOW the ACTUAL performance of the business – you can look at the tax returns, P&L, etc.
  2. Immediate cash flow – You may step into a business that’s already returning a nice cash flow to the owner every month immediately. Start-ups could take years to positive cash flow.
  3. Trained employees in place – Most of our businesses for sale come with well-trained employees already in place. Many have been doing this for years and are experts at what they do. As a new owner, this commodity is invaluable, especially if you don’t know much about the business yet.
  4. Established suppliers and credit – Instead of having to prove yourself and your ability to others in order to get accounts set up, you already have them.
  5. Established customers and referral business – The acquisition will have an established customer base, an asset that can take years to build.
  6. Existing licenses and permits – Licenses can be difficult to obtain. And it may be difficult to learn all that you do need. Existing businesses have learned and instilled what is required . And it turns into a matter of transferring those into your name.
  7. Training by the seller – Very often the seller will help you in the learning process. You benefit from their previous trial and error efforts. Owner can show you the ropes of the business, introduce you to everybody, and make sure its a smooth transition (especially if they are financing your purchase!)
  8. The Owner may provide owner financing – They can kind of become your bank. It is difficult to find a bank to loan money to a startup. Banks have little or no security available in a startup. The reality is that owner financing creates “an interested almost partner type relationship” that has a vested interest in your success. You are on your own- but not really. In startup businesses you are on your own and with all due respect to bankers, I have never been able to view a banker as a partner that would have hands-on assistance in my efforts.

DON’T buy or start a business if your immediate goal is to “be able to spend more time with my family” – long hard hours are usually needed, or “I want to be my own boss and don’t want to have to report to anyone” – even bosses do have to report to IRS, Inspectors, Insurance Co, employees, etc, and “I want my own business because I know it will be easier than my job” – probably wont be.

But if you are seeking a new business venture buying an existing business vs starting a business can greatly increase your chance of success.

Small Business Owners (Most All) Affected by Real Estate Downturn

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The Real Estate Downturn Is Affecting Most All Business Owners.

The real estate downturn is far reaching. Very often we hear about the impact on Realtors, construction trades, mortgage companies etc… But what about the small business owner that is a Printer, a Restaurateur, or growing Web-Based company. Most all businesses are affected by the overall slow down of goods and services, but the real estate downturn has affected business owners in possibly a more significant way.

Many small business owners own real estate. They own the businesses building, they own their private residence, or they own real estate investment property. These business will have financial needs, loans, line of credits, etc.. The bank regularly needs/requires personal guaranty and a personal financial statement from the small business owner. A significant part of that small business owners financial wealth is tied to those real estate holdings and the bank determines this small business to not qualify for a loan or L.O.C., because of depressed value of his/hers real estate holdings.

Real Estate Downturn

Photo (c) estacoes-elevatorias.com

So often in the business world it is said that “it doesn’t matter what an employee or a business does when he/she is on personal time or outside the business”. I find this approach to be flawed. What happens to an employee or small business owner outside the business does matter. The small business owner will find it more difficult to convince the banker of adequate security.

It used to be that you knew you had a lot of money if you lived in a nice neighborhood and had a nicer house/car than your neighbors, now you know you have a lot of money if the bank is willing to loan you money. What happens to a small business owners money outside of his business DOES affect his business.

As of today, September 18, 2009, it is hard, but certainly not impossible for a small business owner to get money from a bank. But you better look good and have “layers” of security for the bank. In the past, I have experienced bank loans for business acquisitions that the bank appeared to have the value of the deal as security, but ultimately tied up the valuable real estate that was associated with the business. The sooner the real estate market turns around, the sooner small business owners will realize the benefits of that turn-around, and use those benefits to help/grow and or sustain their business.

Buying a Business … 1+1=3

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Buying a business can be a valuable business strategy. Synergy is an interesting concept but what can it really mean when buying a business. In my prior business I had made many acquisitions to supplement organic growth. The analysis of buying these business followed the below simplified numbers. A brief explanations of the below numbers –

Say you have 2 like businesses that both are in the business of distributing products or services to homeowners. Both companies have overhead cost of rent, advertising, utilities , insurance, phone, office cost etc. When buying a like company many of these cost become readily duplicitous – i.e. you don’t need 2 offices, you don’t need 2 phone systems.

The below example shows that when Company A buys Company B the fixed cost will not increase at all. When a company does buy another like company many of the fixed cost are eliminated but rarely are all of the fixed cost eliminated.

Financial Gain Of Buying A Business

Buying A Business

Photo (c) laboracademy.org

The example below shows the financial gain available in a well thought out acquisition and this format can be used as a starting point to analyze the synergistic benefits of such an acquisition. The fixed cost that will remain can be added to the Combined company and the projected bottom line should be reviewed to see if the bottom line still looks appealing enough to make the acquisition.

For cash flow purposes I would analyze the initial benefits of buying a like company including the cost of acquisition and the benefit that exist after the financing cost has been realized. In the below example after 5 years the bottom line improves after the note of acquisition is paid down. Financing very often can be available through the business owner selling his company. Usually the business owner can analyze the synergy and cash flow of the acquisition better than an outside banker or other financing means.

Also, when one company buys another company customers are lost and that fact should be considered in the acquisition. Will customers lost be 1%, 5%, 10%, 15%? This all depends on the type of business and parties involved.

Buying a like business can be a very effective means of growing ones company. As a business owner I suggest you open your mind to the concept, look around you at potential opportunities and do the analysis. When analyzing look at best case and worst case scenarios for both projected sales and expenses from buying a like business. As with most business transaction the best business deals are the ones that both parties benefit. When buying a business, the seller can benefit from having a means to exit out of an undesirable situation and the buyer can benefit by eliminating some competition and growing sales.

In today’s economy, businesses are struggling and from this adversity, can come opportunity.

Company A                                                                                            Company B                                                                             New       Company C

Sales $200,000                                                                                        Sales $200,000                                                  Sales                               $400,000

Variable Cost $60,000                                                                        Variable Cost $60,000                        Variable Cost                            $120,000

Fixed Overhead Cost $100,000                                                       Fixed Overhead Cost $100,000              Fixed OH                            $100,000

Profit $40,000                                                                                         Profit $40,000                                                        Profit                           $180,000

 

Global Market – How the Typhoons in Manila affects my small business in Florida Today.

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This Noobpreneur.com website “talks” about many subjects affecting entrepreneurs and small business owners. Franchising, freelancers, marketing, global economy, how to do businesses up and down our own street and how to do business around the world. Ivan ( the owner of this website) has written many post that parallel my interest and efforts as a small business owner and entrepreneur even though he comes from the other side of the globe.

Global Economy And Your Business

Recently, I have been strongly hit in the head regarding the global economy on which I operate. In pursuing my most recent venture, I had elected to hire freelance marketing. I have in the past, used with various levels of success, freelance services out of India. The company I hired and contracted with this time are in the Philippines. They contracted and agreed to perform certain services within a certain time frame. I built my plans around those agreements. They are missing their targets.

I knew they were having some “bad weather over there, but got curious as to if it may be affecting their work. They are being rampaged by storms, rains, typhoons, mud, water, and basically the wrath of Mother Nature. I am out of Southwest Florida, and we are supposed to be in the midst of our “Hurricane Season”, and have had zero storms. Five years ago, the storms were lined up and hitting us one after another and turned our lives upside down. We were evacuated off our barrier island and our lives were at a standstill. Power Lines were down, Internet service, and phones were non-functional for days.

Global Economy And Your Business

Photo (c) foreignpolicy.com

In this case, I could not reach my contact in the Philippines for days, and finally have spoken to them only to really learn of the devastation both physically and emotionally. On our local news between the story of the dog that can catch a Frisbee, and the local crime is sandwiched a short 10 second segment on the storms affecting the Philippines. What does it matter to people in Florida what is going on in the Philippines.?

After reaching to my contact, he told me the stories of his employees living in evacuation centers, mud filling a house “up to the second level”, and just basically traumatized employees trying to cope. (see attached video link http://www.youtube.com/watch?v=A_zXQhuvd6s )

He offered on several occasions to compensate me for the contract shortfall. I felt ashamed that such a thought would even be felt to be necessary. My life is my life, my work is just my work, and is not even a close second. We do live in a global economy. When doing business with India in the past and the Philippines now, I had elected to read their local newspapers to try to get a feel of what may be affecting their daily lives as I know that our work is just a derivative of the world that surrounds us. I know other parts of the world have suffered as a result of Natural disasters and catastrophic events, but living on this little barrier island in the Gulf of Mexico in SW Florida, I feel like these storms were not that far away. And when they get their lives back together, business will resume- but at this point that just does not seem so important.