HOUSTON BUSINESS REVIEW

Tutorial On Selling Your Business: “More Fundamentals on Selling” – Part III
By Ralph Fain

Ralph Fain is a principal in the R/ Fain Group, a professional business brokerage firm which confidentially represents the interests of sellers/ buyers of “Mainstreet to Mid Market” companies (revenues from $1MM to $25MM). Mr. Fain has over 20 years of broad business experience with Fortune 500 companies as well as with small/medium sized companies and has served in various capacities including Controller, Vice President, and President/CEO. Each week he will provide comprehensive information on the many aspects of buying/selling businesses.

Last week’s article covered in some detail Letters of Intent and Offers to Purchase/Purchase Contracts and briefly discussed the Due Diligence process. This week’s article will cover this process in more depth. [Note: Due Diligence (DD) is a process in which the seller obviously participates but it is a process which is conducted and controlled by the buyer and which ultimately is designed to benefit the buyer. As the Due Diligence process is wedged many times between the Letter of Intent stage and the Offer to Purchase stage, we have decided to include this topic in our Tutorial on Selling a Business even though it more appropriately belongs in the series relative to the Buying of a Business. Accordingly, unlike the rest of our articles to date, this article is from the perspective of a buyer.].

As mentioned last time, Due Diligence is the most important step you will undertake when buying a business. It is a process which should encompass a multitude of areas (not solely financial) and should entail a complete review of the business to be purchased.

Of course, it involves the “proving of the financial numbers” – are sales and profits what they were represented to be?; are inventory and fixed assets accounted for and properly valued?; are expenses what they were represented to be – especially those of a recurring nature? The financial review may be the easy part of the Due Diligence process.

It is incumbent upon you, the buyer (and any advisors/consultants hired by you to participate in this process) to immerse yourself in the details of this business and to identify all strengths, weaknesses, opportunities and issues relative to the targeted company – before you purchase it. It doesn’t do you much good to discover, after the purchase, that the business you just bought is in an industry which is in decline and that the company’s major client (accounting for 20% of your revenues) had just recently announced in an industry trade publication that it would be purchasing certain components (currently provided by your recently purchased business) from overseas sources beginning next year.

DD is a detailed investigation not only of the company itself but also of the industry the company is in, the customers and suppliers of the to-be-purchased company, the economy (and future forecasts of same – particularly vis a vis its impact on your industry), governmental policies, etc. For example, you wouldn’t want to purchase a residential dry wall contracting business (whose purchase price is predicated on historical financials showing outstanding growth and profitability) when housing starts are forecast to drop by 50% over the next two years, when interest are expected to rise sharply over a three year period, when immigration policies may change severely impacting your labor supply and costs, and when the price of gypsum will be negatively impacted by governmental tariffs which are scheduled to go into effect next year.

As you can see, Due Diligence is not just limited to a financial review of a company and is not just limited to a general review of that company – it is broadly inclusive. As pertaining to the target company, at a minimum the following should be reviewed – financial results, policies and procedures, products and inventory, corporate culture, operations, clients and vendors, management and personnel, fixed assets and equipment, legal issues, computer technology, sales and marketing, and corporate organization and ownership.

Although what people refer to as formal DD begins upon tender of a Letter of Intent or Purchase Contract, your informal process should begin at the time you have identified a company of interest. From that point you should research the industry the company is in, competition/threats to the industry, weaknesses and prospects of the industry.

The knowledge gained through this research will allow you to investigate the company in a much more thorough and complete manner and will allow you to determine if there are any serious issues with the target company prior to your purchase of same. If there are problems, then it is your choice as to whether to continue with the purchase (albeit under different terms) or to terminate the talks.

As the DD process is brief (generally 7-30 days but sometimes more dependent on the size and complexity of the transaction), you and your consultants must be properly prepared and you must have a plan for the process. In addition, you must ensure that you have contractually allotted yourself sufficient time to conduct a thorough review of the company, industry, etc as per the above.

Buying a business is a serious undertaking. Buying the wrong business is a serious mistake which can be avoided with planning, foresight, and guidance. Buying the right business and achieving the American Dream is priceless – it will be absolutely one of the most satisfying experiences you will ever have!

Next week we will get back to the seller’s perspective and we will discuss Non-compete Agreements and Earn-Outs; following that, articles on Seller Financing (with/without Real Estate) will ensue. As always, see you next time in this same space for our next article. Should you have any questions or require additional information please feel free to contact the R/ Fain Group at 832-646-0832 or via our web site.