If you are in the market to buy an existing business, investigating it thoroughly can provide multiple benefits. Most importantly, your due diligence can help you negotiate the price. Recently, Brown Smith Wallace carefully reviewed a company that a client was eyeing1. The investigation found issues that led the seller to accept more than $5 million less than the original purchase agreement of $50 million.

This advance work can also help protect you from expensive predicaments that may develop after the company is your responsibility. Following these sound strategic fundamentals will pay off.

Perform a Quality of Earnings Review

Clearly, you will want to know how much income the company is earning. But you also need to determine how it's coming up with its numbers. A quality of earnings review will provide insightful answers.

Is the business maintaining strong sales while tamping costs down? That's a big plus. Or, are outside forces beyond its control enhancing its performance? These circumstances could change after you buy the company. Perhaps accounting choices that don't stand up to closer scrutiny are boosting its performance? Clear answers will help you decide whether this is a good acquisition – or if the luster will wear off.

Assess Potential Risks

What assets will be in place to maintain the success of the business? Pay attention to:

  • The management and workers. Does the current owner make all the important decisions, leaving you stepping into a void when you take over? Or will you be inheriting a management team that's trained and able to help you carry the load? People are usually the most important assets of any company, and measures should be taken to address how to retain key employees.

    You might want to check out the background of the employees who may soon be working for you, just as you would likely screen new hires. Learning later that you have an upper-level manager with a checkered history is a surprise best avoided.
  • Fixed assets. The company may not have an accurate, up-to-date list of its fixed assets. Do the resources you think you're getting actually exist and are they working.

    That includes the business' IT system. Is the company using hardware and software that the original equipment manufacturer still supports? If not, the outdated components could lead to sizeable costs – as well as headaches – in the future.
  • Customer and vendor agreements. Does the company have formal agreements with these parties? A lot of your future success with this business could be riding on the durability of these relationships, so be sure you know how strong they are.

Call in Help

This is not an all-inclusive list of factors you will need to know about the business you are considering buying. Understanding the accounting implications of the deal is important, though these catch many people by surprise. But it's important to focus on these To learn more about value drivers when purchasing a company. For more information view a quick video or request an infographic at bswllc.com.2

Footnotes

1. Link to: http://bswllc.com/quality-of-earnings-review-saves-5-million-in-targets-purchase-price/

2. Please link to: http://bswllc.com/watch-our-buy-side-value-drivers-video-or-request-our-infographic/

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.