Starting from scratch is not the only way to go. Most often, buying an existing company is less risky than setting up your own startup. Buyers can rely on the brand’s goodwill, steady customer base, key managers who are familiar with the business inside out.
Buying the right business can make or break you. Buyers should perform due diligence in order to ensure that you have enough information about the business you are buying.
What is due diligence and why it is important
Due diligence is the research that a potential buyer does to assess the viability of a purchase of a business entity. If due diligence is not properly completed, you may be in for an unpleasant surprise after the contract for the purchase of the business is formed and it becomes too late for you to change your mind about purchasing the business. For example, you may discover that the business may have committed to onerous contracts, or that key employees crucial to the success of the business have left.
What to Look Out for When doing Due Diligence
#1 Compliance and Good Standing
It is crucial to ensure that the business is compliant with regulations set out by the statutes or governmental authorities. This prevents the purchase of an incompliant business that could potentially incur fines. Furthermore, it will be difficult for new owners of a business to rectify past wrongdoings of the previous owners as the process would be time-consuming and they would not have a clear understanding of what had happened before they took over the business.
Buyers of a business should also determine if there are any ongoing legal proceedings against the business.
#2 Financial Due Diligence
Performing financial due diligence will allow the buyer to better understand the financial position of the business, enabling him to assess the right price to pay for it. The buyer should also consider the future earnings of the business to determine the financial value of the business. Additionally, the buyer should check if there are any unsettled tax liabilities on profits earned before the completion date for the sale of the business as this ensures that he would not have to bear any additional unforeseen tax liabilities.
#3 Physical Assets
The inventory of a business changes over time. Therefore, it is important for a buyer to check the physical assets of the business to ensure that they are in good condition and are still in the company’s possession. Furthermore, in ascertaining the book value of the assets, the buyer should ensure that the depreciation and amortization of the physical assets are accurately recorded.
#4 Intellectual Property
The buyer should obtain a schedule of all intellectual property rights, both registered and unregistered, belonging to the business. He should also check if any of the registered rights are held in the names of the previous directors or shareholders. Additionally, he should ensure that unregistered or unregistrable rights, such as confidential information and trade secrets, are properly documented and will be transferred to him upon completion of sale.
#5 Key Employees
Key placement holders are integral to the success of a company. The buyer should ensure that the key employees remain with the company using contractual means. Additionally, it is essential to ensure that the employment contracts and employment handbooks comply with employment law. This prevents non-compliant documents that can result in fines.
#6 Licenses and Permits
The buyer should ensure that the business has all necessary licenses and permits required for operation. Some licenses may have been registered under the names of the previous owners. In such cases, the buyer should ascertain if he can successfully reapply for those licenses under his own name.
#7 Material Contracts
The buyer should review all of the business’ contracts to ascertain its rights and obligations. He should also check if there are any change-of-control clauses in the contracts that will result in a breach of contract when the owner of the business changes. The buyer should also assess the risks the company is exposed to.
What Can you do if you Find Red Flags while Doing Due Diligence?
While drafting the contract for the purchase of the business, you can insert warranties and other terms that will protect you from losses suffered upon taking over the business. For example, you can provide in the contract that the seller shall indemnify you for any unsettled tax liabilities, or that the seller warrants that the business is in compliance with all regulations. In the event of a breach of a warranty or a term in the contract, you can claim from the seller any resultant losses flowing from the breach.
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This article is written by Samuel Yuen from Yuen Law and was first published on Yuen Law’s website.
This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to practicing lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Interstellar Group Pte. Ltd. accepts or assumes responsibility, or has any liability, to any person in respect of this article.
