Due Diligence: What You Need to Know Before Buying a Denver Business

You can’t buy a business without a full understanding of what you’re purchasing. And that means you can’t blindly take the owner’s word for much of anything. The process of investigating the business, verifying owner claims, and learning about any liabilities is called due diligence. It can be one of the most involved aspects of purchasing a business, but it’s also the most important. Before undertaking due diligence, you’ll likely need to sign a nondisclosure agreement. Have your lawyer and accountant review this document to ensure you can share due diligence information with third parties involved in the sale, such as your legal and advisory team.

Here’s what you need to investigate as part of the process.

Company Finances

The most critical and basic aspect of due diligence is learning as much as possible about the business’s finances. You should view the balance sheet, five years of profit and loss statements, five years of tax returns, accounts receivable and payable documents, and all audited financial documents.

You should also get a list of business debts, as well as information about any security interest in these debts. Ask also about legal liabilities—potential or ongoing areas of exposure, as well as active litigation.

Explore the Physical Assets

If your purchase includes physical assets such as inventory and equipment, you must ensure the equipment functions properly. With complex or highly valuable equipment, you should hire an expert to inspect it. Leased equipment requires a careful review of the lease, including an assessment of whether that lease can be assigned to you.

Learn About Real Estate

Most businesses use leased space, though some own their own buildings. In either scenario, you need to get a copy of all leases or ownership documents and carefully review them. Assess whether you can continue to occupy the space under the lease, or need to get the landlord’s consent. In some cases, it may make sense to negotiate a new lease. You’ll also need proof that the business is up to date on all rent or mortgage payments.

Check Incorporation Status

On your state’s secretary of state’s home page, check to ensure whether the business is properly incorporated. Then ask your lawyer to assess how ownership might transfer if part of the purchase includes buying the business entity itself.

Get a Personal Guarantee

Even with an exhaustive due diligence process, there may be unpleasant surprises lurking under the surface. The owner must personally guarantee the transaction. You can add this guarantee to the purchase agreement’s representations and warranties.

Don’t Pay Everything at Once

If you pay the full value of the business upfront at closing, this offers you no guarantees should you uncover something untoward. Hold back a portion of the purchase price to be paid six months down the road or once the business hits certain benchmarks. This incentivizes the owner to remain honest and upfront, and offers you some protection should an unanticipated liability emerge.