Chartered Accountants & Business Advisors Phone: 04 569 9069 Email: scw@scw.co.nz Website: www.scw.co.nz
Level 6, Westfield Tower PO Box 30568 45 Knights Road Lower Hutt
DUE DILIGENCE CHECKLIST FOR BUYING A BUSINESS
The purpose of this checklist is to offer some important generalised guidelines as to what to take into account when considering the purchase of an existing business. Relevant information may vary depending on what you are buying e.g. the shareholding in an existing company or the business components of an existing business. This checklist is designed to give you an indication of the type of information you should be looking for and the type of questions you could be asking. This list is by no means an exhaustive checklist but is merely a guideline for you to work on prior to taking expert advice. You must ensure you involve your professional advisor (lawyer and accountant) in working through the issues when buying a business. Similarly try and ensure you have access to the vendors accountants and lawyers to get proper answers to any questions raised. As part of the Due Diligence process when buying a business there are large volumes of information to be gathered and many questions to be asked. Remember the famous statement ‘Let the Buyer Beware”.
THE OPTIONS
1. Buying the Business from the existing owner 2. Buying the shares in the Company owning the Business Generally, the first option is preferred (95% of sales) and the due diligence required for the second option is much more complex.
QUESTIONS TO ASK
You may only get one chance to get it right so select the appropriate questions from the checklist, ask them – make notes of the responses given and don’t hold back. WHY IS THE BUSINESS FOR SALE? People have many valid reasons for wishing to sell their business, and many have strong, established businesses for sale. However, some investigation needs to be done to ensure the reasons given are not just a cover for adverse events which may include: • Declining business • Changes in the character of the neighbourhood • Lack of competitive strength • Impending loss of business due to new competition including competition from imports resulting from changes in Government policy etc.
Page 1 of 8 The information contained in this document is to be read in conjunction with the disclaimer on page 8
Chartered Accountants & Business Advisors Phone: 04 569 9069 Email: scw@scw.co.nz Website: www.scw.co.nz
Level 6, Westfield Tower PO Box 30568 45 Knights Road Lower Hutt
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Obsolete products Poor selections of merchandise or materials Highway construction or re-routing An expiring lease or franchise Obsolete facilities Inability to collect accounts receivable or problems with creditors A need to replace capital assets Owner’s bad reputation which may stay with the business Labour problems
If any of these factors apply the buyer must be able to recognize and resolve them to make a success of the business. FINANCIAL STATEMENTS AND TRADING RESULTS • Obtain Information: (Ensure that this is properly analysed by a competent accountant acting on your behalf): • Obtain copies of the last three years financial statements including profit and loss statements and balance sheets. • Management accounts if any, for periods not covered by the financial statements • The last 3 years income tax returns • Business Activity Statements or Key Performance Indicator reports • GST Returns, Bank Statements or daybooks if applicable • Sales analysis, and an explanation of increases or decreases in turnover over recent months • Detailed analysis of employee records • Attention to the wages and salaries paid and identifying the clear distinction of salaries paid to the owners • Current and future budgets covering income and expenditure • Capital Expenditure budget if applicable THE ASSETS OF THE BUSINESS The assets of the business should be closely investigated to determine their value and to make sure that they are transferable to the new owner. Assets may include – Inventory A physical count should be taken (preferably by an independent valuer) and examined for – • Age • Quality • Saleability • Style
Page 2 of 8 The information contained in this document is to be read in conjunction with the disclaimer on page 8
Chartered Accountants & Business Advisors Phone: 04 569 9069 Email: scw@scw.co.nz Website: www.scw.co.nz
Level 6, Westfield Tower PO Box 30568 45 Knights Road Lower Hutt
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Condition Balance Suitability Freshness & shelf life - obsolescence Costing basis What is the stock control system? Is the stock valuation realistic? Can you physically inspect the stock?
Accounts Receivable If trading is to continue with these customers, investigate the past history by examining – • Their age • The credit standing • How successful has the seller been in past collections? • What discounts have been given? • Is an excess amount of the business coming from credit customers with slow payments records? • Would this necessitate excessive working capital? • If a stricter credit policy were established would key customers be lost? • What is the current economic climate and how does it affect customers’ ability to pay? • Are any credit notes due? • Customers’ lists, business and credit records, mailing lists should be included in the sale agreement. • Obtain a Pareto list – i.e. 80/20 analysis. • Who are the top 10 customers? • What percentage of sales do they account for? Furniture, Fixtures, Equipment, Buildings • Schedule of items to be purchased • Identify those required to maintain the forecast revenue • What is their market value? • How modern, efficient and usable are they? • Will any be useless or soon have to be replaced? • Are all in good repair? • Are they the type you really want in your business? • What is the pattern of past repair costs? • How much has been spent by the seller to keep the facilities in good condition? • What major changes, additions or alterations will be necessary? • Are all items paid for or are there monies owing under a hire purchase or lease agreement? • Are any assets located elsewhere, and if so is clear title held to them? • Has the depreciation policy been realistic, and how has this affected the profits disclosed? • Can you physically inspect the chattels, plant and equipment etc?
Page 3 of 8 The information contained in this document is to be read in conjunction with the disclaimer on page 8
Chartered Accountants & Business Advisors Phone: 04 569 9069 Email: scw@scw.co.nz Website: www.scw.co.nz
Level 6, Westfield Tower PO Box 30568 45 Knights Road Lower Hutt
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Are you satisfied with their condition? Are there any surplus assets? Has a chattels valuation been done? Can you obtain a copy of the fixed asset schedule used for tax purposes?
INTANGIBLE ASSETS Intangible assets can be a significant driver of company value and their proper valuation is very important. For many businesses intangible assets are crucial to success and these important assets may not be recorded on the Statement of Financial Position. When purchasing a business the prospective buyer needs to identify these intangible assets, accurately access their value, and determine the extent to which they are / can be protected. In many businesses the most important assets are relationships with professional advisers, clients, trained staff, systems and manuals, previous experience (know how) and branding. Yet these assets are not recorded on the balance sheet. The questions you need to ask on intangible assets include: • What intellectual property is included in the business for sale? o Trade Marks, Patents, Copyrights, Other Intangibles o Are they included in the agreement? o Are they registered and properly protected? o Are they transferable? o Will they be as valuable in the future? What Rights are included in the business for sale? What Agency or Distribution Agreements are there? o What is their Team? o What are the Conditions? o Are they assignable? Is there a goodwill component?
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LEASE(S) The following questions need to be asked of each lease in place: • Is it transferable to the buyer? • Is it included in the contract agreement so that that the legal obligation to purchase depends on availability of the lease? • Do the covenants of the lease enable the activity envisaged to be carried on? • What type of business can be undertaken on the premises? (this will affect subsequent sale price). • What are the tenants’ rights to sublet? • What is the annual rent payable? • What are the rent review provisions?
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Chartered Accountants & Business Advisors Phone: 04 569 9069 Email: scw@scw.co.nz Website: www.scw.co.nz
Level 6, Westfield Tower PO Box 30568 45 Knights Road Lower Hutt
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What does the lease provide with regard to the payment of rates and increases thereof? How long does it run? What are the terms? Is there an option for renewal? o Is there a deadline for the exercise of this option? Does the lease grant the lessee the right of assignment? Will the buyer be liable, under the terms of the lease, for such expenses as insurance, cleaning, lighting, maintenance etc? Does the rental include a proportion of the profits or turnover? Is there a demolition clause – if so what is the notice period? Is there a relocation clause – what is the notice period? Are there any restrictions on access times for delivery of goods? Who owns the fit out? Do you have to “make good” at the end of the lease? Do you have to give a personal guarantee on the lease?
LIABILITIES All liabilities to be assumed by the new owner should be included in the sale and purchase contract, which should also include a requirement that any claims at the date of acquisition which have not been disclosed, are the liability of the seller. The Liabilities may be extensive and/or hidden and may include – • • • • • • • • • Unpaid bills Chattel mortgages – or security agreements – on equipment Back taxes Liens against the assets Employment Contracts – compliance with Employment Relations Act and Holiday Pays Act Back employee benefit payments including holiday pay, long service pay, sick pay and pending legal suits. Other creditors’ claims Superannuation commitments, redundancy payments and obligations Finance and operating lease obligations
TAXATION MATTERS When purchasing shares in a company – Ensure you get expert tax advice on the following: • • Check that all income tax returns have been filed and proper claims submitted for any incentives or grants. Check the position regarding assessments and payments – are there any current disputes with Inland Revenue?
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Chartered Accountants & Business Advisors Phone: 04 569 9069 Email: scw@scw.co.nz Website: www.scw.co.nz
Level 6, Westfield Tower PO Box 30568 45 Knights Road Lower Hutt
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Review the reconciliation between accounting and taxable profits and consider whether allowance should be made for deferred tax liabilities. Consider the merits of acquiring assets rather than shares. Check that PAYE and GST payments are up to date. Consider tax advantages available through the deductibility of interest on business borrowings.
FRANCHISES • Are exclusive franchises (to sell certain products, for example) transferable to the buyer? • Are they included in the contract? • Is it necessary to contact the franchiser to transfer the franchise? • How long does the franchise run? • What are the terms? • What was its original cost, if any, to the seller? • What is the effect of legislation e.g. - Commerce Act. • What area does it cover? • What is the value to you? SUPPLIERS CREDIT RELATIONS • Are business relations with suppliers good? • What are the trading terms? • Will they continue and on favourable terms? • Are the supply sources satisfactory? • Is there a dependence upon some suppliers? • Is the business committed through contracts to ongoing purchases? • What future deliveries are scheduled for the period after the new owner takes over? • Should they be increased – or cancelled? • Is the estimated average stock turnover greater than the length of credit time granted by suppliers? • Is the length of credit time granted to customers greater than the credit time granted by suppliers? • May agencies be transferred to the buyer? • Are the contracts with suppliers or importers assignable? BUSINESS REPUTATION AND CLIENTELE • Does the business have a good reputation and established, satisfied clientele? • How can past poor service be overcome? • Are there many customers who do business with the vendor out of personal attachment, but would leave if he did? • Does this affect the value of the business? • Does the new owner need to allow for a probable loss of a percentage of customers?
Page 6 of 8 The information contained in this document is to be read in conjunction with the disclaimer on page 8
Chartered Accountants & Business Advisors Phone: 04 569 9069 Email: scw@scw.co.nz Website: www.scw.co.nz
Level 6, Westfield Tower PO Box 30568 45 Knights Road Lower Hutt
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Are there firm contracts with key customers and are these transferable to the new owner? Does the agreement prevent the seller from re-entering business in competition with the new owner? o For how long a period of time and within what area?
STAFF TRAINED PERSONNEL • Will key employees continue to work for the firm under new management? • If key personnel are lost, how adversely will this affect the business? • Will existing employees be an asset or liability to the new owner? • Will the new owner want to make changes? o If so, will there be liabilities for redundancy or loss of office? • Copies of Employment Contracts OTHER FACTORS Carefully consider – • What are past and future trends of the firm, field of business, neighbourhood and community? • What is the history of the location for the past few years? • How many businesses have been there? • What types? • How successful were they? • How long has this business been for sale? • Would it be less expensive to establish a new business rather than meeting the seller’s price? Have you obtained a copy of the Business Plan • Do you have a copy of the Procedures Manual? • Are there backups for the computer systems? Check zoning ordinances and building codes to determine the existence of non-conforming land uses or violations of building codes. Check for future rezoning, re-development, street or highway changes, highway relocation, limited street access, and elimination of on street parking. GROUPED INTANGIBLES AND GOODWILL All those intangibles that are not identified in the above categories and comprise going concern value and goodwill e.g. customer lists, mailing lists, databases built, documented business processes etc COMPLIANCE ISSUES • Does the condition of the building and equipment meet local building and health code requirements? • What is the ACC position and the rating? • Is there an accident register?
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Chartered Accountants & Business Advisors Phone: 04 569 9069 Email: scw@scw.co.nz Website: www.scw.co.nz
Level 6, Westfield Tower PO Box 30568 45 Knights Road Lower Hutt
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Are there any OSH Issues? Are there any negative town planning issues? Check on resource consents required – are they current?
BUYING SHARES IN AN EXISTING COMPANY Should you be doing this then there are further issues you may like to consider: • • • • • • • • • • • • • • • • • • • • • • What is the tax history? Have you sighted the tax assessments? Have you seen the GST returns? Have you sighted the GST assessments? Have you sighted the PAYE assessments? Have you confirmed there are no compliance problems? Are there any cost guarantees? Who are the officers of the company? Does the company have any charges against it? Have you done the company search? Is the company tainted? Do you have a copy of the constitution? Are there any special clauses in the constitution? Are there pre-emptive rights? Has the company been audited? Has the balance sheet been verified? Are all advances collectible? Are your fellow shareholders solvent and substantial? Will there be co shareholder insurance? Have you analysed risk management? What are the remaining take-out provisions re shareholders? Have you read the minute book?
DON’T HESITATE TO CONTACT US SHOULD YOU REQUIRE ANY CLARIFICATION OF THE ABOVE. OR ASSISTANCE IN MANAGING THE DUE DILLIGENCE PROCESS
DISCLAIMER This information is of necessity general in nature. Whilst every effort has been made to ensure accuracy, information contained may not be complete, may have changed or may not be relevant to or appropriate for your circumstances. You must not use the information without seeking professional advice. The information is not intended as legal, accounting, financial or tax advice. Sherwin Chan & Walshe Limited, related organisations, employees and directors are not liable to you or anyone else for decisions or actions resulting from placing reliance on this information.
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