Why is Due Diligence Important When Buying a Business?

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Why is Due Diligence Important When Buying a Business?


In this article:

What is Due Diligence?

Due diligence is the process of examining the business details and data when buying a business. It’s similar to inspecting a home before closing on the house. A buyer will want to check, to name a few things, the financial health of the company, the quality of the standard operating procedures, manuals, policies, tax, legal, and other liabilities. The buyer gets this information by requesting it from the seller. In addition, the seller can get information from third parties such as a tax clearance from the state, to see if or what outstanding taxes the seller has, and liens on any equipment

Why is Due Diligence Important?

The due diligence process is important because by conducting it, the buyer gets to see what he or she is really buying. A buyer shouldn’t take the seller’s word about the value of the business.

Another reason is that if the seller lies to the buyer about anything regarding the seller’s company, the buyer will have no leg to stand on in court because the court will note that the buyer did not bother taking measure to prevent being a victim of fraud. (I published a whole article on this topic).

Lastly, due diligence is important because it forms the basis of the purchase agreement. For example, if, during due diligence, the seller’s equipment was required to be maintained in a specific way and there are no clear records for the maintenance, the buyer can ask the seller to “represent” that the seller did maintain the equipment and warranty the equipment as if it was properly maintain. If the buyer does not do this due diligence research, the buyer may miss out on these remedies.

When Do People Do Due Diligence?

Due diligence is done after the Letter of Intent (LOI) is signed and before the final purchase agreement is signed. A seller will not want to just hand over important documents to a buyer without knowing that the buyer is serious, hence why due diligence is done after the LOI is signed. Due diligence can take as little 2-3 weeks to spanning many months, depending on the size, complexity, and responsiveness of the deal.

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