Due Diligence Checklist when Purchasing a Business


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									This document provides a checklist and summary regarding information and documents
a person should consider when purchasing a business. The sale of a business can be a
complicated transaction and the purchaser should exercise his or her due diligence.
This checklist raises many of the issues that may arise during the sale of a business. It
is important that a potential purchaser review this information to know what assets he or
she is acquiring and what liabilities he or she is assuming. This document also sets
forth some of the state and federal laws which may apply. This checklist should be
reviewed by any potential purchaser of a business.
                    Due Diligence Checklist when Purchasing a Business

        The sale of any ongoing business, even a sole proprietorship, can be a complicated
transaction. The buyer and seller (and their attorneys) must consider the law of contracts,
taxation, real estate, corporations, securities, and antitrust in many situations. Depending on the
nature of the business sold, statutes and regulations concerning the issuance and transfer of
permits, licenses, and/or franchises should be consulted. If a license or franchise is important to
the business, the buyer generally would want to make the sales agreement contingent on such
approval. Sometimes, the buyer will assume certain debts, liabilities, or obligations of the seller.
In such a sale, it is vital that the buyer know exactly what debts he/she is assuming.

        In any sale of a business, the buyer and the seller should make sure that the sale
complies with the Bulk Sales Law of the state whose laws govern the transaction. A bulk sale is
a sale of goods by a business which engages in selling items out of inventory (as opposed to
manufacturing or service industries). Article 6 of the Uniform Commercial Code, which has been
adopted at least in part by all states, governs bulk sales. If the sale involves a business covered
by Article 6 and the parties do not follow the statutory requirements, the sale can be void as
against the seller's creditors, and the buyer may be personally liable to them. Sometimes, rather
than follow all of the requirements of the bulk sales law, a seller will specifically agree to
indemnify the buyer for any liabilities that result to the buyer for failure to comply with the bulk
sales law.

          Of course the seller’s financial statements should be studied by the buyer and/or the
buyers accountants. The balance sheet and other financial reports reflect the financial condition
of the business. The seller should be required to represent that it has no material obligations or
liabilities that were not reflected in the balance sheet and that it will not incur any obligations or
liabilities in the period from the date of the balance sheet to the date of closing, except those
incurred in the regular course of business.

         A sale of a business is considered for tax purposes to be a sale of the various assets
involved. Therefore it is important that the contract allocate parts of the total payment among the
items being sold. For example, the sale may require the transfer of the place of business,
including the real property on which the building(s) of the business are located. The sale might
involve the assignment of a lease, the transfer of good will, equipment, furniture, fixtures,
merchandise, and inventory. The sale may also include the transfer of the business name,
patents, trademarks, copyrights, licenses, permits, insurance policies, notes, accounts
receivables, contracts, cash on hand and on deposit, and other tangible or intangible properties.
It is best to include a broad transfer provision to insure that the entire business is being
transferred to the buyer, with an itemization of at least the more important assets to be

        In making this allocation, the buyer's interests will often conflict with the seller's. The
seller will ordinarily seek to maximize its capital gain and ordinary loss by allocating the price to
items producing such a result. The buyer will normally seek to have the price allocated to
depreciable assets and to inventory in order to maximize ordinary deductions after the business
is acquired.

                                         Due Diligence Checklist

1.       Business Information

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            Reasons business is for sale
            Amount of business for sale (all or part)
            History of business
            Description of products and/or services
            Address of business
            Date and state of incorporation
            States in which the company is qualified to do business
            Minute books, bylaws, certificate of incorporation, and stock certificate book
            Shareholder agreements
            Any special restrictions on the sale
            Shareholders and their holdings
            Rights of each class of stock and other securities
            Capitalization
            Fiscal year
            Accountants- name, address for each
            Attorneys- name, address for each
            Location of company records
            Credit rating
            Bank depositories
            Bank references

2.       Operations

            Description of business, including manufacturing, distribution, and marketing
            Manufacturing history and agreements
            Distribution history and agreements
            Marketing history and agreements
            Advertising history and agreements
            Public relations history and agreements
            Principal vendors and terms
            Government contracts
            Seasonal factors
            Branch offices and associated operations
            Subsidiaries, associated operations, and intercompany dealings
            Documentation on systems & processes

3.       Sales

            Description of the market
            Relative size in the industry
            Major competitors
            Industry trends and recent developments

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            Industry advantages and disadvantages
            Long-range industry prospects
            Client names and address
            Number of customers
            Principal customers
            Customer repeat business
            Pricing policies and fluctuations in the past three years
            Sales backlog
            Sales materials
            Sales personnel compensation
            Effectiveness of advertising and other sales promotion programs
            Gross and net sales for the past three years and for the last twelve months
            Sales comparison with the industry for the past three years and for the past twelve

4.       Personnel

            Organization chart
            Number of employees and their positions
            Employee contracts
            Independent contractor agreements
            Condition and accuracy of employee records
            Union contracts
            Morale and human resource issues
            Consultants - terms and payments
            Pension, profit-sharing, insurance, stock bonus, deferred compensation, and
             severance plans
            Accident history, worker's compensation costs
            Industry comparison as to wage rates and number of employees

5.       Intellectual Property

            Status of patents
            Status of trademarks
            Status of copyrights
            Status of trade secrets
            Status of domain names
            Use of name issues
            Intellectual property ownership - company or individual
            Licensing agreements
            Infringement and other intellectual property litigation
            Protection policies
            United Sates/ international strategies
            Brand management strategies
            Research and development strategies

6.       Business Facilities

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            Location
            Status of leases
            Assignability of leases
            Land owned or leased - description, value, taxes, future plans
            Buildings owned or leased - description, value, taxes, future plans, depreciation
            Furniture, fixtures - description, value, condition, depreciation, useful life
            Insurance coverage
            Ownership of title
            All Uniform Commercial Code (UCC) filings

7.       Computer Systems

            Network system - type, setup
            Computers networked - how many, description
            Computers- condition, value, depreciation- owned or leased
            Computer programs installed - owned or leased
            Vendor and service arrangements

8.       Financial and Related Data

            Tax returns for the past three years
            Annual and quarterly statements, including balance sheets, income statements
            Earnings record, including gross and net profit margins
            Earnings record compared to the industry
            Break-even analysis
            Payroll - federal and state(s)
            Annual and quarterly payroll report
            Sales tax payments - proper filings
            Nonrecurring income and expenses
            Earnings forecast
            Pro forma balance sheet
            Chart of accounts
            Cash and working capital requirements
            Interest charges
            Annual depreciation and capital additions
            Inventory turnover and policies
            Market and book value analysis
            Accounts payable and receivable analysis
            Accounts receivables
            Notes payable and receivable analysis
            Bad debts - collectability and policies
            Analysis of investments or other assets
            Deferred expense analysis
            Analysis of short-term, long-term debenture and mortgage debt
            Existing and potential liens
            Status of leases
            Insurance coverage

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            Contingent liabilities
            Status of any litigation
            Status of licenses or franchises
            Accounting procedures and practices
            Review of all legal counsel opinion letters related to the business

9.       State and Federal Laws and Regulations

            Current federal, state, and local tax status
            Qualifications for doing business
            Certificate of good standing in all states
            Regulatory agency consents and issues
            Antitrust problems
            Blue-sky laws
            SEC filings and problems
            Stock exchange information, if any
            Environmental issues

10.      Comparison Analysis/ Common Ratio Comparisons

            Earnings/book value
            Price/book value
            Price/earnings

         Price/fixed assets
         Sales/accounts receivable
         Sales/fixed assets

11.      Structure of Sale

            Sale of corporate stock - unforeseen liabilities, taxation, corporate liquidation
            Sale of assets - purchase price, allocation, taxation, bulk sales laws, corporate
            Reorganization- mergers

12.      Acquisition Issues

            Purchase price
            Purchase terms
            Financing
            Allocation of acquisition price
            Default issues and return of business considerations
            Brokerage fees
            Reasons for buying or selling

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