How to Buy a Business: Due Diligence
No-one seems to tell buyers this. You’re ready to buy a business. You’ve found one you like, but unsure what to do? I rarely hear anyone talking about these critical factors you should consider when buying a business. Failing to understand these simple things can make or break your business purchase. I've seen firsthand business buyers regretting their purchase within months because they didn’t to this.
When you buy a business, you need to know more than just the financials. But what do you need to do to make a successful business purchase? I’ll tell you the story about a buyer named James and show you what he did to make sure he was successful with his first business.
James had always been driven by a singular dream: to own and operate his own business. After nearly two decades as a tech executive, he felt prepared to transition from employee to business owner. He began the search for a promising business to buy. After months of searching, one company stood out above the rest: A mid-sized software firm.
James knew that the first step was to understand the financial health of the business. He dived into the company's financial statements, scrutinizing income statements, balance sheets, and cash flow statements from the past three years. These showed a steady revenue growth, consistent profitability, and a strong balance sheet with minimal debt. However, James knew that these numbers were just the starting point. To ensure the asking price was fair, he asked the broker how the business value was established and was told that the asking price was arrived at by examining comparable sales, industry multiples, using a fair market value process.
With the financials and price covered, understanding the market and competition was next. James conducted a comprehensive market analysis to understand customer base, market share, and growth potential. The business had some software that set the business apart from competitors. James analysed the industry, making comparisons to other companies in the industry by considering barriers to entry, unique selling propositions, and the competitive advantage the business held.
How did James assess the operational efficiency of the business? He did this by looking at supply chain management, production processes, and overall workflow. He visited the office and was impressed by the streamlined operations and the competence of the management team. The team's continued involvement post-acquisition was vital for business continuity, so James spent time understanding their vision and commitment to the company's future.
James’s next concern was what legal and regulatory factors could impact the business? He ensured all necessary licenses and permits to operate legally were available, and current. He reviewed existing contracts with suppliers, customers, and employees to ensure there were no unfavourable terms that could affect the business post-acquisition. This thorough legal review was essential to avoid any hidden liabilities that could arise after the purchase.
Evaluating the future growth potential was vital in understanding what was to come. James identified several potential areas for growth, such as expanding the product line, entering new markets, and leveraging technological advancements. He also assessed potential risks that could hinder growth, such as tech changes, and economic downturns. Developing a strategy to mitigate these risks was part of his due diligence process.
Just as James felt confident about moving forward with his purchase, he encountered a significant challenge. His legal advisor discovered that a pending lawsuit related to a patent infringement claim. This lawsuit had the potential to impact the financial health of the business significantly. James was faced with a tough decision: should he proceed with the acquisition despite the legal risks, or should he walk away? James decided that the business was still worth pursuing, so he engaged a specialized legal team to evaluate the lawsuit. They provided James with a clearer picture of the risks involved.
James then turned to the competitors as part of understanding market trends and systematically gathered information, including their product offerings, pricing strategies, and customer reviews. Benchmarking against industry standards helped James understand where the company stood in terms of market share, customer satisfaction, and operational efficiency.
James then wanted to use customer analysis to make a more informed buying decision, so he collected data on customer demographics, purchasing behaviour, and preferences through published surveys, interviews, and focus groups. Analysing customer feedback and reviews helped identify trends in customer satisfaction and areas for improvement. This comprehensive customer analysis provided James a view on the strengths and areas where the business could expand its offerings.
Technological trends will always affect a business, so James stayed informed about advancements and innovations that could impact the software industry. He followed tech news sources to stay updated on the latest developments. Assessing how quickly new technologies were being adopted within the industry and their potential impact on business operations and customer experience would affect future growth.
The government regulations that could influence his industry were next. James looked at changes in regulations, trade policies, and labour laws. Understanding common compliance challenges within the industry and how businesses were adapting to regulatory changes helped him anticipate future developments and prepare for potential regulatory shifts.
Supply chain analysis was another critical component of James's due diligence process. He evaluated the stability and reliability of the supply chain, including the availability of raw materials, supplier performance, and potential disruptions, together with tariffs and trade agreements.
Despite the challenges, James was determined to proceed with the acquisition. He negotiated a purchase agreement that included provisions to address the pending lawsuit. His legal team ensured that potential liabilities were accounted for, and he negotiated the price to mitigate the risks. This strategic negotiation helped James mitigate the possible financial impact of the lawsuit while still acquiring a promising business.
James developed a comprehensive strategic plan for his new business’ growth. He focused expanding the product line, and entering new markets. He also planned to invest in research and development to stay ahead of technological advancements. By improving operational efficiency and retaining the talented management team, James aimed to ensure a smooth transition and continued success. To keep a close eye on competitors, James set up Google Alerts for mentions of key competitors and used social media monitoring tools. SEO tools helped him analyse competitors' online presence and marketing strategies. Financial analysis tools provided insights into competitors' financial performance and market share.
James’ meticulous approach paid off and he had achieved his goal of owning a successful business.
Peter Nola is an Auckland based business broker, author and YouTuber with 20 years’ experience and over $100m of businesses sold, helping New Zealand business owners to buy and sell businesses.
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