Podcast

WHY YOU NEED A DUE DILIGENCE WHEN BUYING A BUSINESS

EPISODE 84

About The Show

Buying an existing operational business can be an exciting time. It can also be one of the most dangerous & risky times.
When you buy an existing business you are also buying a lot of potentials for expensive mistakes to occur.
There are many components and moving parts to an existing business such as:
Customers, Suppliers, Finances, Taxes, Landlords, Financiers, Licensing Bodies, Marketing Collateral and Plant & Equipment to name a few.

A properly conducted due diligence of the business you are buying acts as a double check and verification of what it is you are buying and that what you are buying is what you are expecting to buy for your money.

There are many cases where purchasers of businesses have skipped having proper due diligence conducted and it has led to very expensive mistakes and problems once the business is purchased.

What You'll Learn!

  • Why it can be a good idea to buy an existing business.
  • The different ways you can buy an existing business.
  • The risks and potential exposure you face when buying an existing business.
  • What is a Due Diligence
  • Why you need a professional Due Diligence when buying a business.
  • The risks of not having a proper due diligence when buying a business.

Links Mentioned

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Full Episode Transcript

Good day, good day and welcome to the Business Made Easy Podcast where we make business easy, Jason Skinner your host here. For the podcast, it is all about growing your business, growing your bottom line profit, and giving you a better life as a result.

Thank you so much for joining me wherever you are in the world, whatever you’re up to today. I hope it’s going well for you. If you’re at the gym working out, pumping on, make sure you’re doing a good — no straight backs and really putting in that effort.

If you’re out running, I hope that’s going well for you as well. Running is one of my favourite things to do with must admit I’m still not doing it anywhere near as much as I would like but whatever it is you’re up to I hope it’s going well or having a good day wherever you are. It’s a rainy day here on the Gold Coast, another rainy Wednesday. Wednesday is a day that I normally record these podcast and for the last few they’ve been raining. So, I don’t know what that’s all about as we go into winter here in Australia. So, maybe that’s something to do with it. Who knows? We need water anyway. So, that’s good. The farmers and the outback of Australia are certainly still very dry. So, anyway, enough about the weather.

Great episode today but before we get into today’s episode if you haven’t already done so don’t forget that if you have a business question that you wanna answer on the show you can always just drop me a line at [email protected] or join our free Facebook group over at businessmadeeasypodcast.com/community and that’s where a group all sorts of entrepreneurs and members of the Business Made Easy Community you’re over there sharing ideas and asking their questions.
And I’ve got a couple of great questions coming up on the show that I’m gonna answer for you over the next couple weeks so stick around for those. We’ve got some member case studies that people have asked questions and things. So, jump on board over there at businessmadeeasypodcast.com/community and we can uh, get you sorted out there. Free Facebook group is no costs or anything over you didn’t just join and there’s a couple of questions just to sign on. So, I get to know who your business isn’t and the way we go from there. So, oh good.

All right. Let’s get into today’s episode. It’s an episode I like to bring you, I guess, stories and episodes that are real. I won’t say episodes, topics that are real and relevant to businesses and their topics that I come across on a daily basis as I’m coaching clients and helping clients with their to grow their businesses in real life. I come across situations that I think others would benefit from understanding the the situation and understanding the answer. Now, I never give away confidential information. That would be a no-go but I do suddenly change the names and make it as realistic as possible and the interesting as possible for you.

And today’s one is all about buying a business, buying an existing business. Today’s case study is all about buying an existing business. And there are many reasons why you would buy or decide to buy an existing business? It can be a very exciting time when you’re starting a new business or buying a new business for sure absolutely can be an exciting time. It’s probably one of the biggest decisions that you’re making your life to, to buy a business or start a business because it’s a lot of work no matter what you do. If you buy an existing business it’s gonna be a lot of work. And if you buy– if we can start a business it’s gonna be a lot of work, either way, it’s gonna be a lot of work. So, there’s no avoiding that.
Nothing comes free and easy but it can also be a dangerous time when we buy an existing business and I want to go through some of the pitfalls and talk about that today and the way you should approach things when, well, I believe you should approach things when you’re buying an existing business.

Now, as an advisor I see a lot of people come in with optimism in their eyes when they’re going to buy a business because if you go through the buying process you’ve usually identified A) that you wanna be in business yourself, you wanna go into business for yourself and an opportunity normally presents it or you go looking for businesses in the subject area that you want to own a business in. So, you know if you wanted to have an online toy business well, you’d probably the first thing you do is Google online toy businesses for sale or online businesses for sale or find a business broker.

These opportunities we find them because we normally have some eager wants too, to go and have a business in that particular area. Other times these opportunities present themselves. You weren’t actually looking. I’ve seen that happened before. You weren’t actually looking but somebody made an offer or somebody indicated that they were looking at doing that and the light bulb went on and you go, “Wow,” that’ll be a pretty cool business to own. I’d love to explore that further and away you go exploring it.

Now, buying an existing business versus starting a business makes a lot of sense because you’ve already got momentum, haven’t you? You’ve already got customers coming in the door. You’ve already got uh, supplies. You’ve already got probably premises perhaps if it’s a physical brick and mortar business, whatever it is. You might have a website if it’s an online business and uh-and uh, e-commerce store set up. Whatever business it is an existing business makes a lot of sense because there’s momentum and it’s a lot easier to continue and increase the momentum of something that’s already moving that it is to start something from scratch. You picture a rock. It’s a lot more effort to get a rock rolling and moving than it is if, if it’s already rolling along. So, that’s just the law of physics [chuckles] and it’s the same with business because there’s an existing business there and it’s working. So, and has suppliers as I said customers coming in the door except for we hope so anyway.

So, it makes a lot of sense to get an existing business but this is where the dangers can also come about because there’s already transactions that have been happening because has already been agreements and suppliers and all sorts of trading going on with that existing business means there’s also potential liabilities and risks for you as well and this is where the care needs to come in because you could be buying what we call a lot of skeletons in the closet. So, [chuckles] you know, there might be a lot of past bad that that previous business owner has experienced that you now are potentially signing up for and there’d be nothing worse than investing and going on borrowing money, hard-earned money that you’ve got to pay back or you put money or take out a mortgage on your home or whatever the way you’re going to look at funding the business. That’s another topic altogether but you’re going to go in and get that money and put it into something that has a lot of potential skeletons and danger in there that you don’t want to expose yourself too.

So, that’s probably my first point is that you really need to be across the risk associated with whatever it is that you’re buying. Where are the risk points in this transaction that are potentially gonna come back and-and they may be sleeping and lying dormant bu-but something that could flare up and come back and bite you, as you get down the track.
And you could imagine um, if you, you were six months into your new business that you’ve just purchased. Everything seems to be going well. And some transaction that took place. You know, a year or two ago raises its ugly head again and-and now you’re in the hot seat as the owner you know, it’s- it’s very hard to go back to the- the person who sold you the business because they’ve gone. They’ve got their money. They’re sailing around the Caribbean somewhere. We’re still they may have already uh spent all the money. So, they’ve got no money to help you with that risky transaction that could be flaring up. So, lots of things there and skeletons that can raise their head.

Now, when you buy a business there are two ways that you can usually do this. You could buy just the business itself. So if you picture a business structure such like a C corp or uh, uh I think that’s what they called in America a C corp or a S corp or in Australia, they’re called a proprietor limited company. If you think of that as an outer shell and the businesses in the middle of it, you may be able to buy just the business in the middle so you don’t buy the the outer shell or the legal entity that owns the business.

And that’s usually my preferred way that we don’t own, we don’t want to take over somebody else’s legal trading entity if possible. We just want the business itself. So, the trading name, the goodwill, the social media accounts, the website addresses, all those things that are used to run the business, we want all that information but we don’t want the actual entity or business structure that actually owns it because that become—the, that comes with a lot of uh legal um, ramifications potentially. Could you imagine if the previous owner hasn’t been paying their taxes uh, for the last two years or they get a tax audit and you now own their company or their business structure, you’re now potentially liable for, for those debts and it becomes a very hard argument to go back and-and becomes a legal fight really to go back and try and recover that information. And this is for, for this reason, we like to more or less try and limit the risk of-of someone buying the business and actually owning just the business itself not the actual legal structure or legal entity that owns or-or currently operates the business or has done in the past.

So, very important that we consider those sorts of things when we’re looking at buying, buying a business how what are we actually buying? What are we getting from money? And you, it’s probably one of the first questions you wanna ask yourself is what am I actually getting for my money? Am I getting the trading entity as well with all those risks and skeletons or am I just getting the business entity, not the business entity but the business itself, the goodwill and-and the things necessary to run that business.

Now, one of the very-very important documents that I encourage everybody to get or do when they’re buying a business and this is probably the crux of my point today because I’m gonna share with you a story where this didn’t happen and the plight that can actually happen. One of the um, the most important documents or processes that you can do when you’re looking to buy a business is a thing called due diligence, the process called due diligence.

Now, what a lot of people opt to do when they’re buying a business out of sheer excitement and everything’s like rose-coloured glasses that nothing is going- going wrong. So, I don’t need this. The other reason is that they don’t want to incur the cost. They’re going through enough cost. Buying a business as expensive as it is and there’s various fees and charges and- and the like that you have to already incur. So, why would I want to add more? Is it necessary to add more costs to this transaction? And that is due diligence.
And you need to do due diligence. I cannot tell you how many clients, people that I come across that are buying a business, investing large amounts of money and not investing in doing due diligence before they commit to buying the business. So, what is a due diligence and why do people not want to do them? Okay.

A due diligence is basically an extensive check of everything that you are buying, by an independent professional person. Now, you can do due diligence to yourself if you’re adequately um, expertise and equipped in-in-in that regard. Certainly, there’s no legal um, no legal framework that says only qualified people can do due diligence but by investing in a professional person to who, who has experience in doing due diligence and buying and selling businesses and understands the things that can go wrong. We’ll give you an exploratory look at everything in that business if it’s thorough if it’s done thoroughly as to what you’re buying and the risks associated with, with buying.

So, let me take you through an example of things that have been picked up in various due diligences that I’ve been involved in for people for instance. So, imagine you’re um, you’re buying a business and it’s gonna be um, $300,000 for this business and it’s the business, it’s the sale of uh, a going concern. So, you’re buying everything that you need to run that business. You’re not buying the trading entity or such. You’re just buying the trading name. You’re buying the goodwill associated with that business. You’re buying the customer database. You’re buying all the equipment, the plant equipment. Um, you’re buying the website and social media accounts, the phone numbers. I mean what the — we’ll just say it’s physical bricks and mortar walking off the street type uh, retail business.

Let’s say you’re getting all excited and you can see there that you’ve checked the numbers over and you’re satisfied that yes, I can make a go of this business and like there’s a lot of potential there that I can actually improve this business and you know, it’s all, all gonna be uh, all smooth sailing and your, your adviser says to you, “Hey you know, you really should do a due diligence on this business because you know, you may need to highlight– it may highlight some, some anomalies.” And you go, “Look, no. It’s fine. I know the owner.

We’ve done a handshake deal. It’s all good. They’ve had the business for a long time and nothing is going to go wrong. It’s all-all fine. We’ve checked it out. We don’t wanna spend the money and invest the money in doing it.” So, there you go. You’re gonna put three hundred thousand dollars into this, everything. So, you’re ready to go. You’re ready to settle and you get to the settlement date and you find that the lease is about to expire. And you’ve paid your money. You’ve bought the business. And uh, you get in there and you find out not too long after owning the business that the lease only has three months left to go and you have to move out of the business. You have to move out of the premises.

Now, if you’ve got a lot of equipment and all those sorts of things and stock and all that sort of got customers who know where you are this is a huge disruption to your- to your business. You don’t — if you don’t have a premise to operate your business in- in the physical sense for- for a business like that. You don’t have a business really. You’ve got to find somewhere new. You’ve got to refit it out. Now, how much cost and disruption to your business and your profit are that going to make for you when you- when you could have done a due diligence? Spend a few thousand dollars, done our due diligence, and found out before you invested your money before you took over the business that there was no lease in place or the lease was due to expire and that needed to be renegotiated prior to actual purchase. These things can happen and I’ve seen — leasing, in-in terms of leasing of premises that are usually one area that I see a lot of potential risks and mistakes because it involves a landlord and it involves um, particularly in say shopping centres things like that, they have all these little clauses in their lease that uh require you to do a new fit out every, every now and then or um you know extra cost that you need to bear under, under the terms of your lease. And if you don’t do a proper due diligence and have that checked out when you uh, put setting yourself up for a lot of potential risk.

Another-another example let’s say, you buy the business and this time it’s an online business and you get in there and you find out that paid for it, its operational and all going but you find out when you’re just into your-into your actual honeymoon phase we’ll call it of your business, you find out that your main supplier is terminating the agreement with you and you know, or we’re still, there is no actual agreement and they’ve terminating or going to stop supplying to you because they’re supplying to somebody else but your competitors. This can happen. This can happen you know, in a business situation and-and if you haven’t got products to sell and you’ve-you’ve invested your hard-earned money and there’s a lot of risk and exposure there for you that you, you could have avoided by doing a due diligence.

Let’s say in another example you do, you buy a business and you get in there and you find out that a large percentage of your customer or your revenue, your income is coming from a very small group of customers maybe one or two major customers or that puts your investment at a huge risk, a huge risk because if one of those customers goes then you don’t have a business as such. And a due diligence will help find those problems. I’ve seen other situations where um people have bought businesses and they didn’t realize the large amount of employee entitlements that had been accrued that they were now liable for and that wasn’t discussed when they were buying the business.

Again, a due diligence will- will flesh those things out before you commit your hard-earned money in your hard-earned time to actually doing that and-and you know, for that for the investment of say three to four it’s usually about three to four thousand dollars. When we’re talking about that versus saving you fifty, a hundred thousand dollars you know, really is uh, insignificant in the-in the scheme of things but it will um, it- it will drastically, drastically improve your chances of success and protecting your hard-earned, hard-earned money.

So, what are some of the things that are looked at when we do a due diligence? What sort of um, uh, I guess investigations or-or analysis is done, uh, when we’re looking at a due diligence. Well I’ve- I’ve mentioned a couple here. So, basically we look at um, customers. What, what are the mix of the customers and-and who are they? What do they look like? Uh what are the main markets that this business sells in, in-in others markets at risk of um, threats or you know, denies? Um, is there um disruption um somewhere in the business that in the marketplace that that could potentially threaten future profits of the business? Why are the owners actually selling the business?

Do the owners actually see the writing on the wall so they’re getting out and um, they gonna do a hospital pass to somebody else uh, take the money off the table and-and leave you to be the foreperson of that business? So, these are the things that we, we look at. As I said were mentioned before employees and employee benefits, how are they to be treated. How are they—how are they been accruing? What’s the staffing like of the businesses? Are they all long-term staff members or is there a um, we had one situation where all the staff of the new business or the majority of the staff of- of — So, there was a-a– I’ll give you a quick-quick rundown. There was a father and a daughter owned a business and they employed a bulk of their family as employees.

Now, when they were selling the business what was going to happen with all those family members? What was that going to be like when, when the new owners took over the business and they had all these previous fff– owners family working in the business? What was that going to look like? If you don’t look at these sorts of things you can be setting yourself up for, for a really hard time. Are there any outstanding employee litigation matters going on? You know, where-where an employee’s actually got uh, a harassment case or a discrimination case going with the owners at the moment that you’re potentially walking into as well. What’s the culture of the business like?

Now, really-really important to get that staffing um, side of things, right? Um licenses and permits are another one. Do you need any specific licenses and permits that aren’t going to transfer when you buy the business? So, that means you can’t – you ca– you have to set up your own, within a, with a regulatory authority. And uh, are you able to do that quite easily without, without too much hassle? Because if you buy the business and the license doesn’t come with it and, and you need a license well, you can’t trade. So, you know, those things need to get, get looked out really carefully. Are there tax is outstanding? Are there tax audits? Are there tax liabilities floating around that uh, that you need to be aware of? Um, are your suppliers stable? Are they- are they, um able to continue supply to you for your business and-and ongoing you know? What sort of product lines does the business sell? Um, insurances that you need, litigation, is there any litigation that’s been you know, outstanding that that could potentially come back and, and bite you as well?

So, their all things that we, we wanna look at when we, we’re looking at a business. Also too, we wanna see are we paying fair price for the-for the business? You know, is-is-is the price we’re paying really in line with what, what we’re actually buying. Are we getting the websites and the intellectual property so the trademarks um, any trademarks or any um, logos and branding and-and websites and social media accounts? All those things are really important assets of the business that you’re buying and you wanna make sure that they’re all in- all in order when you’re, when you’re taking over, taking over that um, that business. Now, you can see from these things that if you started a business from scratch you wouldn’t necessarily have all these things on day one, they would- they would build over time and I guess that’s the difference when you’re buying something that’s existing yes, you’re getting a head start you’d have to go and reinvent the wheel but you’re also potentially taking on a lot of exposure and-and risk in these areas.

Uh physical assets, what physical assets are you buying? Is their machinery? Is their equipment, vans, cars? Um any particular specific uh, equipment that needs constant replacing or is there any equipment that’s going to need replacing shortly after you take over the business? I’ve seen this before where um, people have — let all just use three thousand dollars again as an example, um, pay, you pay three thousand dollars for the-for the business. You think you’re getting a-a you know and a good investment there you’re going in to start running the business turnaround and machinery starts breaking down and you have to now put your hand in your pocket again and um, buy new equipment a large capital investment on top of your three thousand dollars now to keep, just to keep the business running whereas a proper due diligence could have looked at what’s the age of the equipment, what sort of equipment is there uh, and those sorts of things as well. So, you can see here. You know, I think you’re getting the picture that there are a lot of, lot of things that need to be looked at when you’re buying an existing running concern, a going concern business um, because you really wanna make sure that the organization that you’re buying is a healthy, healthy well-respected organization in the um, in the marketplace. And unfortunately, there are just unscrupulous operators out there. People that have taken shortcuts in the past that um, that you know, they’ve seen the writing on the wall. So the-the first reaction is to panic and sell, sell the business. Um, the old saying and-and look I’ve seen this, look I keep coming back to this in practice so many times.

The old saying, um if it sounds too good to be true it usually is. I can tell you right now, it is no one- no one is giving you that extra bonus for nothing and- and uh, quite often the other way. So, uh, you really need to do your own work and do a due diligence um, before you actually uh, look to buying a business, okay? I really can’t stress that enough and I can’t tell you how many people have fallen foul of not doing it.

It’s-it’s just one of those things. Um, and I see it all the time people come in and I’ll say, “By buying this business X, Y, Z like, great. Have you done our due diligence or-or uh, are you going to do a due diligence?” And they go, “What’s that?” I explained it to them just as I have to you today. And I tell them the price and then they go, “Uh, no. Um, we will save our money on that because we’re gonna buy the business anyway.” And honestly it’s just so, so dangerous and um, and- and a lot of paying can be avoided just for that small investment I’ve actually done it.

And I’m not saying you have to do it through, through me. And so that’s not the purpose of today’s podcast. The-the purpose of today’s podcast is to help you if you’re looking at buying a business or you’ve been considering buying a business to-to-to consider those things and go and see your professional advisor and get assistance before taking that leap and um, and putting you know risking- risking your hard-earned uh, money or borrowed money even worse you know, and that’s another thing I guess, another document I would put in place along with uh, with the due diligence is I would if you are borrowing money, that money needs to be paid back out of the profits of the business and that that’s usually paid back after tax.

So, you really need to sit down with your adviser also and make sure that your cash flow, um, from the business is going to be able to support the borrowings that your, you’re going to be taking out to buy that business because I’ve seen that happen before too.

The amount—the repayment schedule of the loan that the bank put on you is you know, and borrow the money to buy the business and you-you’re relying on this profit of this business to make the loan repayments and provide a living for you but the amount that bank wants you to repay is more than your actual cash flow coming out of the business because you, you haven’t sort of, you haven’t done that proper cash flow and a professional advisor will help you with that as well and um, it’s a must document to a company that the due diligence and um, you know, you also want a valuation in there as well but certainly would make sure that I’ve got at least those two documents to um, to the due diligence uh, and also the um, uh, the cash flow to make sure that you can fund it and it’s and you’re not going to have pressure because once you’ve signed on the dotted line and you’ve crossed the line and you’ve got the keys to that [chuckles] you got the keys to that new, new business then uh you’re responsible and that’s where you can cause yourself a lot of stress and strain if you don’t take the proper steps and have the right help and support and that’s what we’re here to do for you as well on the Business Made Easy Podcast. That’s what we’re all about making you uh, helping you to, to try and avoid those pitfalls uh, whatever you’re doing in your business.

All right. That’s all I wanted to cover with you today. Due diligence, what to- what to do, and what they cover and what’s involved. If you’ve got any questions at all around due diligence to feel free to jump over into the Facebook group.

I’ll help you over there at, businessmadeeasypodcast.com/community and uh, you can or you can always just drop me a line at [email protected] and I will uh, more than happily help you and point you in the right direction as well.

Thank you so much for joining me. I really do appreciate you listening in- every week like you do. If you’re new to the show just remember to hit that subscribe button. Uh, you can follow us on- on Spotify, now we are on Spotify. So uh, and the listenership is growing quite considerably over there on Spotify. It’s a great platform too, to listen to podcasts. So uh, it’s where I- it’s where I go to listen to all of mine as well. All righty. Thank you so much for joining me. I’m glad uh, you’ve been able to join this episode and until next week. I’m going to uh, hand you over to Mia and uh, here’s to your success. All the best guys and see you next week. Take us out Mia.

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