The purchaser of a business must be confident that they are getting what they pay for. Looked at differently, the purchaser needs to know what they are getting in order to determine what they should pay for the business. To that end, the purchaser, with help of counsel and often a financial expert, must investigate several aspects of the business.
Business Entity Itself. Regardless of whether the transaction will be an asset purchase or a stock or membership purchase, the purchaser must understand the type of business being considered, i.e., corporation, limited liability company, partnership, etc. Due diligence should include a thorough review of any shareholders agreements, operating agreements, partnership agreements and the like to determine whether they are up-to-date and whether they have been complied with as they relate to the impending transaction. It must also be determined whether accurate and timely records have been kept, including minutes of meetings. All shareholders/owners must be identified, and the purchaser must determine how their ownership interest is represented and evidenced.
Financial Matters. The purchaser must obtain and thoroughly review the business’ essential financial information as this is a primary factor in determining a purchase price and determining profitability based upon the existence of sound financial records. This review should involve a qualified financial expert such as a certified public accountant. A thorough review of financial matters should involve a review of at least three years of state and federal tax filings, as well as any documents related to sales and payroll tax payments to the appropriate governmental entities.
Company Contracts. The purchaser must acquire a firm understanding of the business’ contractual obligations and rights with landlords, banks, customers, vendors, equipment lessors, governmental entities, employees and other third parties. An analysis of these various contracts is important because they play a significant role in determining the value of the business.
Permits and Licenses. Businesses are regulated for several reasons and at multiple levels of government, including the local, state and federal level. Due diligence in connection with a business purchase should include the marshaling and review of all licenses and permits necessary for the operation of the business. Of particular importance is whether the licenses and permits are transferable and if they are, the process for accomplishing the transfer must be understood so as to determine timing and its effect on the transaction.
Employment Matters. The purchaser must understand bonus plans and existing bonus payment obligations, sick leave and vacation plans and accruals. Existing employment agreements must be reviewed to determine financial obligations to employees and to understand which key employees are bound to stay on-board due to non-compete agreements and which employees may need to be encouraged to stay because they are not likewise bound.
Real Property Issues. Due diligence includes a thorough review of the physical facilities to determine how it is owned or otherwise held and the associated financial obligations, including those arising out of maintenance obligations. Of course, the value of real property will depend on its condition. There may be environmental concerns, deferred maintenance issues or problems with compliance with the Americans with Disability Act which must be remedied. Further, there may be restrictions such as easements, zoning, etc., that may affect use of the real property and thus, may affect any plans the purchaser may have for the real property.
Litigation. Existing and potential litigation is an important consideration when purchasing a business. Even past litigation is relevant because it could bestow or impose current rights and obligations on the business that affect value. Accordingly, past, current and potential litigation must be considered on a wide range of matters, such as customer and vendor contracts, personal and property claims, employment related matters and any regulatory claims brought by any governmental entities. To be sure, asset purchases (as opposed to stock or membership interest purchases) may not insulate the purchaser from certain litigation outcomes or regulatory sanctions. Among other things, a firm understanding of these matters assists counsel in considering and drafting indemnity and holdback provisions.
Other Matters. Before signing a purchase contract, all key terms of the contract must be thoroughly reviewed. This includes clearly describing the business and the assets to be acquired, as well as the seller’s and the purchaser’s obligations in terms of deliverables at closing, including any documents. The purchaser must understand what, if any, conditions must be satisfied for closing, as well as the parties’ rights upon default.
Patrick J. Van Zanen