POST 8: PRIOR TO DUE DILIGENCE

Once the seller signs and returns the LOI, you are now set to begin Phase 2, the Due Diligence. Typically another month may pass by this time. Therefore, the normal timeline from initial stages of search to the point where you have a LOI signed off by all parties could be from 45 to 60 days.

The LOI signed by all parties concerned will carry several conditions similar to the real estate offer. Regardless of the number of conditions, the two that are most important are the completion of the due diligence to the satisfaction of the buyer (you) and approval of financing on terms and conditions satisfactory to you. Due diligence is the process of reviewing in detail any and all items that pertain to the business and identifying discrepancies and anomalies that might reveal poor business practices by the current owner. Due Diligence will also require the seller to reveal all pertinent information including required regulatory approvals, liens, lawsuits, etc, etc. As mentioned earlier, you should ask for 30 days for due diligence and nothing less than that.

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Dimple2001

POST 9 - DUE DILIGENCE

The process of due diligence begins as soon as you take possession of the original signed LOI. At this time, start compiling all the questions you would want to ask the seller and list of information you’d like from the seller. Here is a list of first round of questions/information request for the seller, again, not in any particular order. I say it is the first round since the response from the seller for the above list will inevitably trigger further list of questions. Some of the questions need to be addressed to the accountant and the lawyer as well.

1. If the business is a franchise, how will the franchise agreement transfer? Is it simply an ownership transfer or a new agreement to be signed identical to one that is in existence?
2. Financial statements for the current year till most recent month (usually will be in the form of monthly P&L – Profit & Loss Statement as there won’t be a financial statement yet)
3. Complete financial statements – Balance Sheet, Income Statement, Cash Flow Statement and all pertaining notes.
4. Financial statements for at least 3 prior years.
5. Business tax returns for at least 3 prior years.
6. Articles of incorporation.
7. How are the net profits of prior and current years being utilized (bank, investments, re-investment, accounts receivables, etc)
8. Sample invoice/receipts/evidence for each of the operating expense item.
9. If there are operating expenses such as bank charges and amortization, ask for an explanation of what is inside and what is being depreciated or paid for?
10. Ask for explanation on any item that seems abnormally high. For example, if repairs are listed as $30,000 every year, ask why the repairs are recurring?
11. Ask for explanation for any numbers that don’t tally up between the most recent time to the most recent financial statement. Usually, the most recent P&L would provide the answer, but it is good to ask.
12. Ask for explanation if there are discrepancies between what the seller verbally mentioned to what is actually stipulated in the agreement. For instance, if the seller verbally mentioned utilities are included in the building lease, but the lease agreement states otherwise, the seller needs to clarify through hard evidence.
13. Usually, financial statements combine several items under one description of expense. Ask for a breakdown. Conversely, ask how the seller is paying for a particular item. For example, ask who pays for the copier if leased and where is it included in the expenses.
14. Regardless of the above items, clarify in detail all of the operating expense (what is included within those items).
15. Ask how earned revenue is determined. This is important if the client pays in installments. Is it determined as earned now or is it as it is earned. The GAAP (Generally Accepted Accounting Principles) would dictate some of these accounting methods, but in a small business, you don’t know how much the seller is into “fuzzy math”.
16. Ask for all sales records to substantiate the revenue.
17. Ask for the entire building rental agreement and the contract terms.
18. Ask to see the advertising contracts if you will be taking over.
19. Ask to see the content of the advertisements.
20. Ask to see detailed breakdown of the wages and benefits?
21. Ask to see every employee and contractor’s employment/contract agreement (to check for any perks paid beyond wages/benefits – ex: gas money, mileage, overtime, etc)
22. Verify the source withholding, health benefits, etc for the employees.
23. Need details of all overhead.
24. It is one thing what the employment agreement/contract states as of now and it is another what the employees actually got paid due to bonus, extras and what not. Therefore, ask to see the T4 amounts for at least 2 prior years to verify if they tally with the total wages and benefits on the financial statements. This should include the T4 amounts of the seller and his family if they are on payroll.
25. Ask to see the details and names of all vendors and suppliers.
26. Ask to see the contracts with all vendors and suppliers.
27. Plan ahead to discuss legal transfers of:
a. Master business licence (in the case of share sale)
b. Lease agreement
c. Lease agreement
d. Franchise agreement (if applicable)
e. Phone numbers
f. Utilities
g. Bank accounts
h. Insurance policies
i. Internet accounts

28. Ask details of all the equipment, fixtures, etc and understand who owns them in the event the building landlord requires you to move out.
29. Need to evaluate all the inventory, signs, decorations, furniture, etc.
30. Need a complete list of liabilities.
31. Need a breakdown of all accounts receivables and by age 30, 60 and 90 days and beyond. Longer they are outstanding, lower is the value of that account.
32. Need a breakdown of accounts payable, broken down by 30, 60, 90 and beyond number of days.
33. Need disclosure of all debts.
34. On the rental agreement, clarify any additional rent that would be part of common area costs.
35. Ask to see details of all the insurance the business need to and is carrying right now.

Once the list is ready to go, email it to the seller and request the seller to provide detailed response to each of the items in the list. The seller would normally require 2 to 5 days to get the responses and documents to you.

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Dimple2001

POST 10: DURING DUE DILIGENCE

While you are waiting, contact the banker and the accountant and let them know that you have signed a LOI and waiting response from the seller on all the items. This will be the time to begin the process of obtaining financing approval from the banker. The banker will normally have you fill out a profile questionnaire and an application form that details your assets, liabilities, residence history and employment history. The accountant will require you to sign an engagement letter that forms the basis of your relationship with the accountant for this business deal.

In my case, the banker took about 4 business days, after I submitted my profile and application, to prepare a proposal package and forward it to the financing agency. The banker then contacted me and asked me to submit a business plan summary. Since I had not done a business plan in my life before, I went fishing on the internet and found sample business plans published by Scotia Bank for the three common structures of businesses – sole proprietorship, partnership and corporation.

You can download the pdf sample of the business plan. Since I did not want to reinvent the wheel, I scanned the business plan into a OCR document using my Dell scanner. This gave me the editable form of the sample business plan which I used to “create” my business plan.

At this point, in my situation, I started receiving bits and pieces of the information I had requested from the seller. This information triggered further questions. The frustrating part was the seller sending me incomplete information or he appeared to withhold information when I asked for detailed explanation. After several iterations of questions and request for information, I discovered, on several instances, the seller was unable/unwilling to provide hard copy of evidence of the numbers and information he was claiming. Therefore, I contacted the seller and told him of my intent to withdraw from the deal and returned whatever proprietary documents I had.

If the deal had gone ahead, the steps would be to complete the due diligence, obtain the necessary financing, remove all the conditions stipulated in the LOI, prepare a purchase agreement and close the deal.

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Dimple2001

Thanks Dimple for the explanation.
and they used to say that Canada was one of the easiest countries to start a business (and of course buy an existing business)
No wonder with all this kind paper work, many businesses are going under. The latest is "Sweek Mahal- AKA Novelty" selling buffet for $8.99 + HST.
I am thankful that I am a salaried employee.
PEace

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I am a Gents and not a Ladies.

The posts are well written and may be helpful for those who are thinking to start a business.

From my personal view these are more daunting and would rather discourage most of the people to start a new business.

This is indeed one of the best information that is ever posted on CD .
The information provided is quite exhaustive .
OP has dedicated his valuable time to provide each and every possible detail .
I am sure that many of us will not do certain mistakes that we were bound prior to the information provided .
Once again thanks for sparing your time and posting .
God Bless you .

AG

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Growing Old Is Mandatory ..Growing UP is Optional

Quote:

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Originally posted by tamilkuravan

Thanks Dimple for the explanation.
and they used to say that Canada was one of the easiest countries to start a business (and of course buy an existing business)
No wonder with all this kind paper work, many businesses are going under. The latest is "Sweek Mahal- AKA Novelty" selling buffet for $8.99 + HST.
I am thankful that I am a salaried employee.
PEace

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Dimple2001