How Should I Conduct A Due Diligence Check Before Purchasing A Business?

When purchasing a business, it is essential to ensure that the business is suitable for your needs, and that the company has commercial viability. In this way, it is standard practice to conduct a due diligence check. When you conduct due diligence, you will be reviewing the company’s performance, financial capability, legal information and current contracts and agreements. This will allow to determine whether you are receiving a good deal for the business, or whether further negotiations are necessary. 

When Should a Due Diligence Check be Conducted?

It would be most beneficial to do a due diligence check after you and the seller have agreed on the purchase, but before you sign the sale of business contract. This will enable you to ensure that the terms you have agreed to are suitable and appropriate. Furthermore, it will enable you to negotiate or clarify any points or uncertainties with the seller before binding formalities are completed.

What Should be Checked?

Business Structure

When completing your due diligence, it is firstly important to ensure that the business you are intending to buy is suitable for you, with reference to your prior experience, funds and interests. These following considerations may also inform your decision:

  • Is the business a part of a franchise? If so, you will need to comply with the franchisor’s operations manual, which is a document that outlines how to run the franchise efficiently with relation to the company’s standards and protocols.
  • Are there any regulations that the business has to comply with? These could be related to the health and safety of both employees as well as customers.
  • Does the business have the required permissions to perform the business functions you intend? For example, if you are looking to run a hairdressing business, does the lease allow for this?
  • Is there any pending litigation with the business?
  • What is the financial position of the business?

The Seller

Consider the reasons why the seller is selling the business; this may inform your decision as to whether it is an appropriate investment for you. In particular, take into account:

  • The reasons for the sale;
  • Whether the seller held a highly specialised role in the business, and whether you can match this; and
  • Whether the seller intends to open a competing business, which could affect your business’ success.

To ensure a smooth transition, you may also wish to observe how the seller runs the business to pick up on business techniques and strategies for success. This may also give you an idea of how the business is run, and whether this is something you can commit to.

Commercial Viability and Potential Competition

Another aspect which should be considered before you purchase a business is how successful the industry is, and whether there are strong prospects for the future.

  • For example, it may not be beneficial to purchase a business that deals with developing film for photos, given that most people now prefer to take photos on their phone or digital camera.

You may also think about whether the business you are intending to purchase predominantly deals in a unique, hard-to-find item, that will give you a competitive edge in the industry.

You should also consider how strong the competition is, both in relation to nearby businesses, as well as online businesses .

Suppliers

When reviewing the sale of business contract, you should check if existing supplier contracts are being transferred to you. This is particularly relevant where your business deals with physical goods. You may also need to confirm this with the supplier. You should do this especially if you are happy with the quality of the stock, and would like to retain existing suppliers. It is also important that you review:

  • When contracts end;
  • What fees/payments are involved;
  • Whether there are minimum purchase conditions (and what fees apply if these aren’t met);
  • Whether incorrect or unsuitable stock will be replaced/refunded; and
  • Whether the business you intend to buy has any unwritten agreements with suppliers that can be transferred to you. 

Location

It is a good idea to consider whether the location of the business is favourable, particularly with regard to factors such as:

  • Whether the premises will allow you carry out the proposed business activity;
  • Noise levels;
  • Parking facilities;
  • Traffic; and
  • Accessibility

The future success of businesses could also be affected by any restructuring/construction plans, so be sure to check local council and government agency records to see if there are any impending:

  • Road developments;
  • Rezoning plans;
  • Public works;
  • Town planning changes; and
  • Developments

Staff

If you intend to retain the existing staff, you should ensure that their working rights are up to par. In particular, ensure that staff members:

  • Have a visa, and work rights within Australia;
  • Have valid employment contracts with the business;
  • Are qualified for their job;
  • Are being paid the correct salary and entitlements (follow this link for information on pay guides and minimum wages);
  • Are entitled to employee benefits such as annual leave, sick leave and superannuation; and
  • Possess any necessary licences or further documents (such as a Working With Children Check for childcare jobs).

Leases

If the business operates from physical premises such as a shopfront, review the sale of business contract to check if the lease agreement is included as part of the assets which will be transferred to you. Some contracts may require the buyer to enter into a new lease agreement. You should consider:

  • What the rent and other expenses are;
  • If there are rent increases each year, by how much;
  • What the insurance, security deposits or collaterals are;
  • What your responsibilities are regarding the maintenance of the premises and inspections; and
  • When the lease ends.

Key Takeaways

  • Before you commit to purchasing a business, ensure you complete your due diligence to confirm that it is suitable for your needs.
  • Consider the prior performance of the business, and likely success in the future.
  • Ensure that the motivations for selling the business are not uncertain, and all legal requirements are being followed.

If you have any questions about purchasing a business, you can contact Lord Commercial Lawyer’s business purchase lawyers on 9600 0162 or email us at info@lordlaw.com.au or fill out the form on this page.