Expert Answer

Lance Hood:               Let's wrap this thing up by talking about due diligence and closing the deal. Most people have heard the term "due diligence." I assume it just means a financial review of a company. What exactly does it mean, and when does it happen?

Richard Parker:           Due diligence is a time when you'll have complete access to all of the company's books and records to validate what has been represented and to be certain that everything is true and accurate. One thing that is very important is that due diligence goes way beyond the numbers. To the average person, the lay person, their interpretation of due diligence is exactly the way you just phrased that question. But it is far greater than that. It's really the period when you must evaluate the assets, the contracts, the employees, suppliers, the lease, legal issues, the marketing, the sales, the competition, the employees, et cetera.

I mean, it's also the final stage in the deal and really your last chance to walk from the deal with it only costing you your time. And the way we tell people how to structure transactions, language is always included that you can withdraw from the deal for any reason whatsoever. It is your sole and absolute discretion right up until the end of the due diligence period and get the complete return of any deposit you may have put up without penalty whatsoever or further obligation.

And so when you look at this due diligence period that's the final frontier, that's the time when anything that has to be evaluated, uncovered, researched, et cetera, that's when it has got to be done. That's the last step. It's the last step for when the only thing you still have at risk is your time. After that it's money on the table and that is why it's so important to do a good job of it.

Lance Hood:               Richard, like you said, the forms that you have will tie the business up until you can get to the due diligence. So you don't have to worry about another buyer coming in and trying to get the business out from under you, right?

Richard Parker:           That is correct. I mean, we tie them up so that the business can't be shopped anywhere else. They can't market the business. The broker can't accept any backup offers, nothing. I mean, the seller is tied up, we have language that we recommend people use, and also have an attorney review of course, the does not tie up the buyer and doesn't tie up their money that they get penalized and have any possibility whatsoever of their deposit being at risk.

Our due diligence section in the material loan is 40 plus pages. I mean, we break it down into a 200 point checklist that segments all of the individual areas that I just talked about; the assets, contracts, employees, suppliers, et cetera. It breaks it down into each one of those different categories so you know exactly what it is that you have to evaluate and you're able to rip through the due diligence in a very effective manner.

Lance Hood:               You have 22 key points that you must know before you seal the deal. Can you share some of those with us?

Richard Parker:           First of all, you need to allow yourself enough time. There are some sellers and brokers that try to negotiate to get you to agree, believe it or not, when I tell you this this is so crazy - get you to agree to do your due diligence in five days. Yeah, isn't that ridiculous? And then even crazier than that there are some standard contracts in the business broker industry that have that in there. And there are some that are worse that they say you have five days to do it, but worse than that, if the numbers that are presented, or that you uncover, or that you verify, are within 5% of what the seller has told you, then you can't back out of the deal.

So let's take a look at this in example. I mean I know this is sort of expanding upon this point, but let's take an example where the numbers are dead on to what you evaluated or what you were told they were. They're dead on, dollar for dollar. But then you find out that one customer represents 80% of the business. Or then you find out that the building is subject to eminent domain by the local government and they are knocking it over and you're looking at a retail store that relies on all the local traffic. So yeah, great, the numbers tie in perfectly, but do you think I'm going to buy this business? I mean, you need to have your head examined, right?

So the first thing is to allow enough time to do it without restrictions, without contingencies, "I have X amount of time to rip through this as I see fit to evaluate what I want, to determine whether or not, at my choice, at my sole discretion with absolutely no influence, no conditions related to what can influence that decision. That is my decision." So you allow yourself enough time because again, yeah in five days you can look at the financial, I mean typically a good accountant can rip through the financials in a few days. That is not a hard. Numbers are numbers. Numbers don't lie. It's everything else that needs to be evaluated that we talked about.

So first give yourself enough time to do it, and typically I like to see 21 days to 30 days or 20 calendar days, somewhere in that neighborhood gives you enough time. Also, if you get to the end of the period and you don't have everything covered that you need to, you just get an extension. That is why deals fall apart. Would you believe that 50% of all the small business transactions that are agreed to in contract fall apart in due diligence, 50%, and that's because a good part of them, the buyers uncover things that were not disclosed, and in an equal amount of cases, the buyers get to the end of it and they haven't done their homework. They haven't done their research properly, so they don't have this feel that they remembered everything, that they have covered everything. There are too many unknowns. They are not comfortable with moving forward.

It's like when you go to the airport how oftentimes you say, "I'm sure I forgot something." Right? When you're on your way to the airport, "I'm sure I forgot something." Right? Probably because you did. Oftentimes that you didn't, but very often that you did. Or something you forgot to do.

So buyers get through the due diligence stage and they say, "I just don't feel comfortable about this or that or what about this, what about that?" Well, if you don't allow yourself enough time and you're not adequately prepared, then you're never going to be able to proceed with the transaction because you just don't feel comfortable and you think there is something sort of under the rug that you have not uncovered yet.

Do your homework, prepare properly and you'll reach a proper conclusion rather than saying, "I just don't feel comfortable." I just don't feel comfortable is not a rational answer. So you need to list out every single issue that has to be investigated and you should set this all up as a to-do list of things that you have to go through during due diligence.

Third point would be don't wait until the due diligence period officially starts for you to begin your review. As soon as you find a business that is even remotely interesting to you, you have to start investigating that business. You have to start doing your due diligence. Because an effective due diligence must start the moment a business is of interest to you.

Now there is not everything that you can do from day one, you find a listing online, I mean you can't do due diligence on it, you don't even have the numbers. But you can start to investigate the industry; you can investigate the area that they're located. Certain things like that. And as soon as you start meeting with the seller and asking questions, that leads to more research. So you can do that parallel to all of this so that when you arrive at the time of due diligence and you have a limited period in which to complete it, you're not sitting there with this overwhelming daunting task, you've done a good part of it already.

The fourth point would be hire the best possible professionals you can afford. You're going to need an accountant to assist you with the due diligence and the financial review. No matter how good you are with the numbers, it is always good to have someone else look at them. And same with an attorney early on when the contracts are being drafted. Hire the best possible attorneys and accountants that you can afford. And this is not the case of saying, "Well, I got an attorney, it's my wife's cousin Jim, he is a patent attorney, lives up in Illinois, he is a really sharp kid." He's a patent attorney; he is not a transaction attorney, okay?

So hire the best qualified attorneys and accountants that you can possibly afford because they're going to make all the difference and the money that you're going to spend on their fees is meaningless compared to what you have at stake.

And the last thing is provide the seller with detailed lists of all the documents you need and don't let the clock start until you have all of them. There's a standard checklist that an accountant's going to give you that you're going to need such as bank statements, tax returns, et cetera, and there are other documents you need; a copy of the lease, a copy of any employee agreements, copies of any contracts, copies of insurance policies, all of these type of things.

That list that you provide the seller you're going to give to them before they started the due diligence period and unless there is something so minor on that list, other than that, don't let the clock start to tick with the due diligence period until you have all of those documents.

So those are really five key issues that I would identify out of the many more towards 22 that need to be considered in advance.

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