It's what you don't know that can hurt you
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Due Diligence Specific to Internet Businesses
When buying a business you wants to examine your goods before you pays your
money. Perfectly reasonable in any acquisition or merger.
Nobody wants nasty surprises and to protect against them takes a bit of
work.
In essence, the buyer of a business is looking for reasons to not invest in the
company.
Due diligence involves looking closely at all the company's records:
statutory financial statements; internal process controls; management accounts,
budgets, analyses and projections/forecasts; contracts with employees,
suppliers, customers and others; insurance policies... and
assembling the jigsaw.
But the job doesn't end there. Just examining the inventory records would
mean nothing if the stock on hand falls far short of what the books suggest. The
research needs to go much further. Many of the potential buyer's questions
impose a considerable time demand on the person selling his business. For example, the buyer may
require a description of the industry, pricing policies of major competitors,
the preparation of various management accountancy charts etc. Sellers
expect this, it's par for the course.
For the buyer it's about asking the right questions and looking in the
right places.
That's why it tends to be done by specialists. Some business brokers offer
this service (where
to find the right business broker) as do accountants and some consultants.
 But it's not unknown for buyers to do the due diligence themselves,
particularly when they believe the amount involved doesn't warrant the expense
of professional advisers or when the business is a relatively simple one
(perhaps just a domain that's been rented out i.e. no stock, employees or
suppliers). Here are some of the questions asked in the due diligence processs:
Questions About The proposition Itself
- Is the auction listing or sales memorandum professional and comprehensive?
(is the seller serious about selling?)
- Are all partners willing sellers?
- Does the sales memorandum give a quick and satisfactory overview of the company?
- Is there a balance between fact and qualifying opinion? (is the seller "over
selling"?)
Questions About The Business
- Is there a clear description of the product or service?
- Does the product meet the needs of the target customers?
- Is there an expanding (or at least stable) market for the product?
- Who are the main competitors and how do they compare on quality/price/service?
- Is the business scalable?
- Are trading laws and regulatory requirements being met?
- Any recent bad publicity or adverse comments at places like Better Business
Bureau?
- Any issue with continuing relationships with suppliers or difficulty in
getting raw materials, services, licenses or premises?
- Any large increases in rent, labour or other costs on the horizon?
- Is there any other large impending cost e.g. obsolete machinery or other
capital requirement?
- Is there over reliance on a particular employee, supplier or customer?
Financial Questions
- Is there an unambiguous and complete explanation of the revenue streams?
- How good are the cash flows?
- How accurate is the valuation of their assets?
- Are there any hidden liabilities?
- Are there any irregularities in the financial statements?
- What is the company's history with financial compliance?
- What have the auditors said about the company figures over the last few years?
- Have authorities conducted any tax related investigations into the company's
finances?
- How reliable are the financial projections?
- Have terms and duration of the overdraft and other credit facilities been
disclosed and is there any risk to those facilities continuing?
People Related Questions
- What do background checks on the owners of the company reveal?
- Are staffing levels adequate?
- Are key employees staying?
- Does the firm's insurance include cover for key personnel?
- Is management/board of directors capable and experienced?
- Are any existing or ex-staff under any non-compete contracts?
- Have all profit sharing, deferred compensation and non cash earnings been
disclosed?
- How easy is it to replace staff and/or find suitable people with the right
skills?
- Do the employment contracts comply with existing legislation?
- Do proper record exist for all aspects of the HR function?
- Is the company up to date with all employee related taxes?
- Have you sight of all documents relating to loans, consulting etc.with
officers, directors and related parties?
Legal Questions
- Have all articles of incorporation, tax registration certificates, board
meeting minutes, shareholding records etc been provided?
- Are there any pending legal cases or threats of action (and has potential
damage been quantified)?
- Is there a history of past cases (do settlement documents exist)?
- Has all litigation related material been made available for inspection?
- Is there satisfactory evidence of ownership of Intellectual Property?
- Have copies of mortgage deeds, titles, leases etc. been provided?
- Are the accounts, regulatory filings and tax payments all up to date?
Conclusion: There is no such thing as an exhaustive list of questions
when performing due diligence. And, if I may remind you, it's what you don't
know that hurts.
Relevant links:
Get a full checklist for Internet Businesses
What Documents to Look at Before Buying a Business
(pdf)
Checks specific to franchises: What Due Diligence Should I Perform Before Investing in a Franchise?
Due Diligence Checklist for
Business Acquisition or Sale (pdf)
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Performing Due Diligence on Internet Businesses
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