Researching the Business

After finding a business that is for sale and that seems a likely prospect for you to run successfully, you should spend enough time to thoroughly investigate the business. You should definitely get your lawyer and accountant involved in this process, as well.

By thoroughly investigating the business (doing "due diligence," in business-speak), you increase the chances of making a decision that is right for you. The time spent investigating the business, the industry, and the market will make you confident that your decision to buy (or not to buy) was the right one.

In many cases, the seller will not give you any sensitive information about the business unless you have signed a letter of intent that, essentially, makes a non-binding offer for the business, and you have also signed a confidentiality agreement promising that you won't use the information for any purpose other than making the decision to buy.

Keep in mind that if a business is for sale, there must be a reason why. That reason may be because of a problem such as poor cash-flow, bad management or a poor economy. A thorough investigation should reveal any existing problems and enable you to weigh those problems in your purchasing decision.

A business investigation is usually performed before the business is bought but can continue after the sale. In such a case, some of the sales proceeds will probably be held in escrow until the investigation is completed, or your contract may provide that the seller will reimburse you if certain types of problems turn up. A business investigation involves taking a hard, objective look at every aspect of the business. In many instances, however, time will not permit you to investigate the business as thoroughly as you would like.

Required Review

Yet certain basic inquiries should be made. At a minimum, you should examine the following documents:

• Organizational documents — documents that show how the business is organized, such as partnership agreements, articles of incorporation, and business certificates, should be examined to determine how the business is structured and capitalized.
• Contracts and leases — documents such as property and machinery leases, sales contracts, or purchase contracts should be examined to determine the exact obligations the business is subject to.
• Financial statements — examine the financial statements for the past three years (and longer if available) to determine the financial condition of the business.
• Tax returns — examine the tax returns for the past three years (and longer if available) to determine the profitability of the business and the whether any tax liability is outstanding.

Below is a checklist of documents you should obtain from any business you are thinking about buying.

• Asset list including real estate, equipment, and intangible assets like patents, trademarks, and licenses
• Real and personal property documents (e.g., deeds, leases, appraisals, mortgages, loans, insurance policies)
• Bank account list
• Financial statements for the last three to five years
• Tax returns for as many years as possible
• Customer list
• Sales records
• Supplier/purchaser list
• Contracts that the business is a party to
• Advertisements, sales brochures, product packaging and enclosures, and any other marketing materials
• Inventory receipts (also take a look at the inventory itself, to check the amount and condition)
• Organizational charts and resumes of key employees
• Payroll, benefits, and employee pension or profit-sharing plan information
• Certificates issued by federal, state, or local agencies (e.g., certificate of existence, certificate of authority to transact business, liquor license)
• Certificates, registration articles, and any amendments filed with any federal, state, or local agency (e.g., articles of incorporation for a corporation, articles of organization for a limited liability company)
• Organizational documents (e.g., corporate bylaws, partnership agreements, operating agreements for limited liability companies)
• List of owners, if more than one (e.g. all shareholders if a corporation, all partners if a partnership, all members if a limited liability company)