Whether you’re buying a business, investing in commercial real estate or acquiring another company, signing a contract can mean a significant financial commitment. Once that agreement is signed, it may be difficult to undo the transaction.
That is why due diligence matters. It’s crucial you understand what you are agreeing to, what you are purchasing and what risks you may be taking on.
What should due diligence cover?
A business or investment may look good on paper, but problems can remain hidden unless there is a careful review. Due diligence allows you to identify problems and determine whether you want to move forward with the transaction.
Every transaction has its own unique set of circumstances; however, several areas commonly deserve close attention.
- Financial records: Financial due diligence can help determine whether a business is performing as represented. Reviewing financial statements, tax returns, cash flow, outstanding loans and other records may reveal financial obligations that weren’t apparent initially.
- Contract and legal obligations: Contracts can create obligations that continue after a transaction closes. For example, a commercial lease may contain restrictions that could affect the business’ future operations.
- Liabilities and litigation: A buyer needs to know about existing or potential liabilities before completing a transaction. Discovering a legal dispute before signing may allow both parties to address the issue or reconsider the deal as a whole.
- Business operations: Financial statements only tell part of the story. Due diligence involves seeing how the business actually operates. Does the business depend heavily on one supplier or customer? Is it using outdated equipment or technology? These issues can affect the value of the business.
- Licenses and regulatory compliance: Businesses are often subject to a variety of federal, state and local requirements depending on their industry and location. Buyers should determine whether the business has the required licenses and permits and is complying with applicable regulations.
One of the biggest mistakes a buyer can make is treating due diligence as an afterthought. Signing first and investigating later can leave you with limited options if you discover a problem.
It’s essential to work with someone who can help you determine what should be investigated and identify legal issues that may not be obvious at first glance. Making an informed decision protects your interests before the deal is done.