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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

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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.

Failure to Plan is Like Planning to Fail when Selling your Business

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When should one begin the planning for the sale of your business?

It has been said that that thought process should begin when you start your business. So Entrepreneurs, while in the initial throes and excitement of the planning stages of starting a new venture, it is also appropriate to broach the subject of exit strategy. Too often the daily process of running and growing the business disallows the consideration of an exit strategy.

Do You Have An Exit Plan?

A recent study (as printed below) conducted revealed that 75% of small business owners do not have an exit plan.

SACRAMENTO, Calif., Sept. 29 /PRNewswire/ — The California Association of Business Brokers (CABB, a non profit trade organization) says that there is one thing that most small business owners fail to do when preparing to sell their business: have an exit strategy in place. A recently reported study conducted by Harris Interactive found that among those small business owners surveyed, three out of four small business owners did not have an exit plan developed.

An Exit strategy may be transitioning your business to family members, a planned merger, a planned closure, a planned sale of your business, or other possibilities. The below is focused on issues related to the planned sale of your business.

How NOT to Consider an Exit Strategy:

Exit Strategy

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  1. Wake up one morning and say I hate what I am doing, call a business broker and ask to sell your business ASAP. Now if you wake up 60 morning in a row and hate what you are doing it may warrant a call to a business broker to discuss the potential sale of your business.
  2. Wait until an unexpected illness strike you, before you begin the process of exploring the strategy of setting up your business for sale.
  3. Enjoy the good years of business success and allow this success to keep you from developing an exit strategy, and then wait until your business is faltering and can no longer support its own cash flow requirements and then be forced to sell your business in this adverse environment.

Things TO DO when Considering an Exit Strategy

  • Give yourself time, pick a time horizon 2-3+ years out to perform task that would aid in the sale of your business.
  • Try to understand the approximate value of your business. Your business may be one of your most significant assets, and just knowing it for net worth purposes and planning purposes can be invaluable. www.sellabusinessflorida.com
  • Focus on improving the quality of your numbers and your records. Look at your income statements, and balance sheets objectively and see if numbers stand out or jump out as hard to explain, or unusual. Any reports or figures that results in error that are “carried forward”, or allowed to exist – have them reconciled.
  • Work on systems. The more systems in place to more well thought out your business looks. The more systems in place, adds value to a new owner and improves both value and the likelihood of success to the new owner that buys your business.

When is a good time to BEGIN the process of evaluating a good exit strategy for your business? TODAY

How Much? – when buying or selling a business

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You buy products or services and one of the first thoughts you have is – How Much?  You sell products or services to customers and one of the first thing a customer wants to know is- How Much? Somebody looks at buying a business and again needs to know – How Much?  And a business owner is ready to sell his business and either move on to other business interest or retire and he needs to determine – How Much.

How does a business owner determine how much his business is worth? The reality of the matter is that the marketplace ,as with most business transactions, determine how much is the worth of the business.  But in order to attempt to sell your business and market you business a value, or a price range needs to be determined to allow potential buyers the opportunity to see if your price goals match with the price range they are willing to pay.

When discussing the concept of valuing a business or setting a range and or target sell price of business with business owners some times the wrong criteria is initially considered by the business owner.  Sometimes the “What I need to make when I sell my business” is different than “what the business is worth.  Consider the example of a business owner invested $50,000 as an initial investment into his business and owes another $100,000 on some equipment he bought and is still paying off.  I might ask the business owner if he has considered what he would want to sell his business for and he may say “I need to at least get $150,000 for the business because of the above reasons.”  Actually the business owner is telling you what he believes he needs to get out of the business, yet this does not necessarily represent potential value to the buyer.

When business owners or entrepreneurs set prices for products and services certainly cost is a significant contributor to determining price point of that product or service.  What like or similar products or services are selling for is also considered.  But the successful and ongoing sales of that product or service is dependent upon how the customer values your product or service.  Does your customer believe that they are getting fair value for the price of your product or service.  The fact that you now lease a new expensive company car- does that enter into the pricing of your product or service.  It may to you but very possibly/probably it does not to the customer.

This is a similar thought process that should go into the question of how much should I sell my business for.  If a person can buy a similar business to yours and buy it for 40% less than yours why would they buy your business.  The price/value needs to make sense.  And if all else is similar it is reasonable to expect the potential buyer of your business to expect your business to be priced similar to other like businesses.   And the fact that you invest more initially into your business or owe $x on  the business, or lease an expensive new car really does not speak to value or pricing (unless liabilities are following the new buyer and may decrease the value to the new buyer)

The best scenario for selling your business is always a scenario which allows for you the business owner to plan that exit strategy.  Part of that planning process is trying to determine what you believe you need to get out of the business for the sale to make sense to you (also allowing for tax consequences of such a sale.) But it is important that what you need to make when selling your business and what your business is worth when selling your business are 2 separate matters.  While these are 2 separate matters that often get convoluted in the thought process of a business owner – it is very pragmatic to target a potential time to sell your business as a time when “what I need to get out of business when I sell my business” is at least equal or less than “the sell price or value of my business.”  Ultimately the somewhat complex process of setting a price of a business for sale (or a product or service for sale) gets reduced to How Much are your selling your business for? and the answer being How Much are you willing to pay.

Need a Job? Buy a Job – Buy a Business

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Consider the various routes successful entrepreneurs business owners take when building a successful operation.  It is important to consider that the path taken is varied, and success need not necessarily follow one specific path.  Bill Gates did not invent the MS-DOS program that became the Windows operating system we know today.  Entrepreneurs can start with an idea, and turn it into a successful business venture.  Entrepreneurs can buy a business, step in and continue that operation and grow it.  Entrepreneurs can “buy a job.”

“You Are Not Buying a Business You Are Buying a Job”

This statement has been attributed to certain business opportunities that potential business buyers or entrepreneurs are evaluating.  Is it wrong to buy a business, when what you are doing is” buying a job”?  Firstly what the statement is intended to denote is that, you will be an integral part of the daily operation, the business may not operate properly without your daily workload, you will not necessarily be in a fixed overhead or supervisory role but rather part of the variable cost of running an operation.  You will be buying a business that you be working at in the day to day operations.

Buy A JobFor example if your spouse and you buy an existing business that is a 2 man Sandwich shop- you may be “buying a job.”  At times the prospects of “buying a job” in lieu of buying a business is viewed as a negative.  Is it wrong to “buy a job.”  Personally I dont think so.  Consider the scenario of the employee that worked for the same company for 15 years, walks in his office one Monday morning to learn that he has been let go, downsized, fired, or  laid-off.  When YOU buy your own business or buy your own job,  WHO is going to walk in your office and fire you? Nobody.  You have control of your destiny not always offered when working for others.  When you own your own business you know how the company is doing.  You don’t spend a minute of your time concerning yourself on how your superiors view your performance.

Do you ever wonder where the largest source of buyers of business comes from.  Most future buyers of business are employees right now, or were employees and have been let go and are ready to sieze more control over their destiny.  Currently I am working with a few people of which are both the combination of currently employed and recently let go. Whether you buy a business or look to start your own business, your should be prepared for some hard work. You will probably work harder and stress more than when working for others but does the trade off of control and working for yourself make it worth it?  Today one is buying a business in a buyers market.  More sellers are offering seller financing when selling their business.  Maybe it is a good time to buy a job