Wednesday, June 4, 2014

Buying a Home Based Business Part 4: Due Diligence

image This article was written by Mike Capsuto, SCORE Orange County Business Mentor

Ten days ago I couldn’t spell “entrepreneur”, now I are one. Unknown

Many people rush into buying a business with their “eyes wide shut” - there's more to what you are seeing that, without closer inspection, you simply don't see. Sales listings can exaggerate or conceal important information that if known could negatively affect a buyer's decision. Due diligence is the precautionary research a buyer performs to verify the information provided by the seller and to make further inquiries to uncover information and identify opportunities or risks in the company's performance.

This process is usually conducted in the 60 to 90 days prior to buying a business after the buyer and the seller have signed a letter of intent in which the seller agrees to gives access to all business data, including finances, sales figures, customer data. This is not a go alone process. It requires involvement of legal and financial advisers as well as technology experts.

Information in this article is provided for general educational use only. No responsibility is assumed for any problems associated with the use of its content. One should seek the advice of their financial and legal counsel in every step of purchasing a business.

The starting point for the due diligence process is a thorough review of the financial statements and its underlying data. This includes the verification of the value of fixed assets, inventory, accounts receivable, and liabilities. The buyer's accountant should review profitability and check company financial data against common financial ratios to note any positive or negative trends or unexplained changes. Review the tax filings and note any discrepancies with the financial records.

Other important areas needing review include:

General company information:

A history of the company, its original and any succeeding business plans, the company's mission statement and short-term and long-term goals and objectives. You can use this retrospective to compare which goals were achieved or exceeded and to establish the next set of goals for your business.

Legal matters:

Depending on the legal structure of the business, review copies of the articles of incorporation, by-laws, minutes of meetings, and formation documents, any partnership agreements or LLC filings. Other legal documents would be copies of contracts and agreements binding the company, warranties/service agreements on company products and any product liability documents. A discussion of current or pending litigation as well as any relationships with regulatory agencies or industry-specific organizations.

Personnel:

Home based businesses have few if any employees physically located in the home. However, there may be employees located in warehouses, delivery, or outside sales. Obtain a listing of all employees, their functions and employment contracts if any. Documents relating to employee hiring, pay, and benefits need to be reviewed. Review employment tax reports (Forms I9, 941, 940 and others), both federal and state. Check the status of independent contractors to make sure they are correctly classified.

Products and services:

If the company sells products, a catalog or listing of products is needed, along with cost, pricing strategies and information about competitiveness of these products. Brochures and price listings for products and services must be reviewed. Documents relating to company patents, copyrights, and trademarks must be provided, as well as licenses owned by the company and agreements with licensees.

Marketing and competition information:

Documents needed include the company's marketing plan, market analysis, growth opportunities, and purchase agreements. Information about the competition include lists of major competitors, and analysis of the competition - present and future.

Intellectual property:

Most Home businesses rely heavily on the internet to sell their product or services. It is not uncommon to discover that they do not have ownership of the designs, databases and software source code for their website. This can be problematic if no agreement on web ownership is specified. These means an application may have to be completely re-built, or cannot be modified without using the original developers. Sometimes ownership or control of the primary domain name resides with another party. This should be identified and ownership verified.

Third parties:

Most home based businesses rely on third parties. There will often be contracts with payment authorization services, external hosting companies and fulfillment services. The success of the business may be highly dependent upon all of these working together. Contracts may be expiring or need to be renegotiated with a change of ownership.

Sensitive data:

State and Federal regulations mandate that adequate consent has been acquired to track the use of personal data and credit information. Data source information, consents, uses, data retention & disposal policies and procedures should be reviewed.

Security:

Hacking is a major problem with commercial websites. Security considerations should be built into all stages of the website application from design through implementation. Evidence of security problems, verification, detection and incident handling processes should be evaluated. Backup procedures for disaster recovery and business continuity should exist and have been tested. Otherwise customer and other valuable data could be lost due to an accident or technical fault.

Operations:

The maintenance and ongoing development may allow access by third parties to sensitive data and information. Examine who has access to the system. Details of previous and upcoming scheduled maintenance may reveal system problems..

Confirm the website traffic claims:

Review the load monitoring data. Obtain statistics on hits, page views, visitors Is some of the traffic the seller claims actually traffic that was secretly paid for?

Due diligence can be costly, because it usually involves the services of outside advisers. Without "due diligence" one may end up buying something that is not what was expected, or end up in a business relationship that will cause a loss of your personal investment and that of others.