Didn’t Finish Your Due Diligence? Prepare to Overpay

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If it’s true that time is money, this can easily be seen by comparing the amount of due diligence a potential business owner completes with the price he ends up paying to purchase a company. Very rarely is a business priced based on its true worth so you, the potential business owner, have to know how to avoid overpaying.

Although the previous owner may tell you that they are selling the business for a noble reason, that is rarely the case. Feeding children in Africa, spending more time with family, or buying a dream house in Maui are all seemingly benign reasons to exit a business but think about this: If a business is truly profitable, why wouldn’t the owner attempt to become a more silent partner in the company? Of course it may true that they want to take their profits  but don’t assume the best.

Due Diligence is simply the act of turning over every rock no matter how small. Challenge every figure, visually inspect every asset and crunch your own numbers. If you and your team complete your due diligence correctly, there will be virtually no information that you have that wasn’t a result of uncovering it yourself. Remember that the price tag on this business is a result of the current owner’s inflated and sometimes falsified documents.

What are a few of the many important actions to take during the due diligence process?

The owner’s income projections mean nothing! These numbers are most likely drastically overinflated. Do your market research as if the company doesn’t exist. Think like a start up business and see if the local market can support this business. Ask similar business owners in other territories how they are doing, and consult trade organizations for statistics. Just as the owner projected inflated numbers, your projections should aim low. And don’t forget to add loan payments in to your cash flow projections.

If the current inventory is part of your negotiations, ask for paperwork that documents the age of current inventory. Just because it’s there doesn’t mean it’s going to sell. Just like any other asset, inventory loses value over time so buying it all at “cost” would be grossly overpaying.

Visually inspect all assets. This is not only to check the condition but also to verify that it’s physically present. For larger equipment do enough research to know the amount of depreciation and find comps that give you an idea of its value. The owner will most likely over inflate the value. Also, make sure all items are present when you get the keys. Finally, don’t accept an all or nothing deal. If you don’t need certain pieces of equipment, don’t purchase them.

New Versus Used. Finally, your due diligence should culminate with two different calculations, one showing the real cost to purchase this business and the other showing the cost of starting from scratch. Don’t purchase a business if starting new will be the same amount. Valuing the customer base is a difficult task but if the tangible assets that are already used will cost nearly as much as new equipment, purchasing a floor full of used equipment, some of which you may not need, probably doesn’t make sense.

Due diligence takes a large amount of time and this is only a small list of actions you must take before valuing a company. If you don’t take the time to complete the work, you will overpay. Just because you were the winning bidder doesn’t mean you won if you haven’t first completed your due diligence.