Conduct Due Diligence
Immediately after the seller accepts your offer, you can start conducting due diligence. Due diligence is never perfect. You can never be absolutely assured that the business is without problems. In most circumstances, you can walk away from the transaction if you are unsatisfied for any reason during due diligence, and your earnest money deposit will be refunded.
Documents to Review
During due diligence, you will review many documents, including financial statements, bank statements, tax returns, lease information, and additional detailed documents about the business. If the seller is financing the transaction, you should also provide them with a copy of your credit report, bank statement, and background check upon acceptance of your offer.
Purpose of Due Diligence
Businesses are complicated. There are hundreds of factors you must take into consideration. When evaluating a house for sale, you can look and quickly form an opinion on the value and suitability of the home. Houses and other tangible purchases often require little to no due diligence. However, buying a business involves assessing many intangible variables that are not readily apparent and are more difficult to evaluate.
With a business, you must first make an offer. The seller’s representations are verified only after an agreement is mutually agreed upon regarding the basic terms of the deal. Before receiving an offer, most sellers are cautious regarding the information they show to a buyer. If all buyers conducted their due diligence before making an offer, sellers would spend a tremendous amount of time with many buyers with whom they may never reach an agreement in the end.
Length of Due Diligence
Due diligence can take any period of time, as long as both you and the seller agree to it. The typical due diligence period for small to mid-sized businesses is 30 days. These factors can impact the length of due diligence:
- Availability of information: If the seller responds promptly to your document requests, the due diligence period can be shorter.
- Turnaround time: This depends on how fast you review the information. If you are provided information that’s concise, organized, and clear, the due diligence period can be expedited.
- Communication: Making yourself more available to the seller can also shorten the due diligence period.
The Role of ‘Representations’ and ‘Warranties’
There is no such thing as a perfect business. If due diligence doesn’t ensure that the business is problem-free, then what can be done?
“Representations” and “warranties” are statements and guarantees by the seller of a business relating to the assets, liabilities, and other elements of the business being sold. Representations and warranties (reps & warranties) are included in the purchase agreement that is signed at the closing. They assure you that legal remedies are available if the seller fails to disclose any key facts regarding the business that you don’t discover during due diligence.
In the purchase agreement, the seller will make factual statements regarding the condition of the business, covering nearly all aspects of the company. Essentially, the seller is assuring you that their representations are true. If proven to be otherwise, you are entitled to seek legal remedies, which could result in the seller paying you for damages.
Conclude Due Diligence
Sometime during the due diligence period, or upon its expiration, you may decide you are satisfied with your investigation and are ready to continue with the transaction. When this happens, you and the seller sign a “Conclusion of Due Diligence,” documenting that the contingencies have been resolved.
Contingencies that Survive Due Diligence
There are often contingencies that survive due diligence, such as bank financing, franchisor approval, lease assignment, or license transfers. These contingencies are resolved between the conclusion of due diligence and the closing and will be noted in the Conclusion of Due Diligence document.
Open Escrow and Additional Deposit
Upon signing the Conclusion of Due Diligence, you will place an additional deposit with the escrow company if you are an individual or if you are purchasing a small business. These deposits will be applied to the final purchase price.