EVALUATING THE COMPANY: DUE DILIGENCE
The first step for a buyer evaluating a company is to study the company's history and operation. It is also important to learn how the nature of the business may have changed since its inception. A buyer should understand the company's methods of acquiring and serving its customers and how the functions of sales, marketing, finance and operations work and interrelate. General information about the industry can be obtained from trade associations, consultants and other resources.
The company's financial statements, operating practices and other documents should be reviewed. Many items must be looked into prior to making an offer. However, others can be reviewed or verified only after a bona fide offer to purchase the company has been made and accepted -- contingent on satisfactory verification of any unreviewed items.
Please answer or explain the status of these items in order to enable us to produce a business presentation package and marketing plan for your business.
1. Accounts receivable aging schedule and determine if there is concentration in a few accounts.
2. Reasons for any overdue accounts.
3. Are any amounts in dispute?
4. Do the delinquent accounts have the ability to pay?
5. Are any of the accounts pledged as collateral?
6. Is the allowance for doubtful accounts sufficient?
7. What is the policy for granting credit?
8. Is accounting/record keeping computerized?
(this section may or may not apply to you)
Machinery and Equipment
Notes Payable and Mortgages Payable
The potential earning power of the company should be
analyzed by reviewing profit and loss statements for the past three to five
years. It is important to substantiate financial information by reviewing the
company's federal and/or state tax returns. The company's earning power is a
function of more than bottom-line profits or losses. The owner's salary and
fringe benefits, noncash expenses and nonrecurring expenses should also be
calculated. The four-step formula for this calculation is noted in the Pricing
the Company section under the subheading Income
Any and all sales records, such as sales journals and sales reports, should be used to verify sales information on the income statement. Furthermore, sales journals can help determine the level of sales concentration among key customers.
While analyzing the balance sheet and income statement,
sales and operating ratios should be calculated. Some of the most important
ratios are the current ratio, quick ratio, accounts receivable turnover,
inventory turnover and sales/accounts receivable. The significance of these
ratios, the methods for calculating them and industry averages are available
through Dun & Bradstreet and Robert Morris Associates. Buyers will look for
trends in the ratios over the past three to five years.
1. What is the remaining term of the lease?
2. Are there any option periods, and if so, how is the option exercised?
3. Is there a percentage of sales clause?
4. What additional fees (such as a common area maintenance or merchants' association dues) are paid over and above the base rent?
5. Is the tenant or landlord responsible for maintaining the roof and the heating and air-conditioning system?
6. Is a periodic rent increase required to adjust for changes in the consumer price index or for an increase in real estate tax assessment?
7. Is there a demolition clause?
8. Under what terms and conditions will the landlord permit an assumption or extension of the existing lease?
1. What are the job responsibilities, rates of pay and benefits of each employee?
2. What is each employee's tenure?
3. What is the level of each employee's skill in his or her position?
4. Do any employees have an employment contract?
5. Will key employees stay after the company is purchased?
6. Are any employees part of a union or is any union organizing effort likely?
7. What employee benefits does the company offer?
8. Review any employment handbooks or policy manuals.
1. Are any of the products proprietary?
2. Describe any upcoming products and projected sales.
3. What is the company's geographic market area?
4. What is the company's percentage of market share?
5. What are the company's competitive advantages?
6. What are the company's annual marketing expenditures?
7. How are marketing strategies determined?
A list of trade names, trademarks, logos, copyrights and
patents should be obtained, noting the time remaining before each expires.
1. Are FICA, unemployment and sales tax payments current?
2. What was the date and the outcome of the last Internal Revenue Service (IRS) audit?
1. Are there any suits now or soon to commence?
2. What OSHA and EPA requirements must be met and are they currently being met? If not, what is the extent of the company's liability? An environmental audit may be appropriate.
3. Are all state registration requirements and regulations being met?
4. Are all local zoning requirements being met?
5. Review the articles of incorporation, minute books, bylaws and/or shareholder agreements.
6. What are the classes of stock issued by the corporation and the restrictions of each, if any?
7. Has any stock been canceled or repurchased?
8. Is the business a franchise? If so, review the franchise agreement.
9. Are licenses required to operate the business transferable?
10. What is the company's returned goods policy and the extent of its liability for returned goods?
11. What is the company's liability for product warranty claims?
1. Who are the company's competitors?
2. What is the company's market share?
3. What are each competitor's competitive advantages and disadvantages?
4. What advantages or disadvantages does the company have?
All the factors identified in this section on evaluating a company must be carefully scrutinized and weighed. Some factors will have a positive influence on the decision to buy and others a negative influence. Seek professional assistance if necessary to interpret the significance of the information. The important thing is to obtain all the information needed to make a decision.
In most instances, all business records should be made
available to the buyer. In some cases, however, certain information may be
withheld until a bona fide offer, contingent upon obtaining that information,
has been made. If important information is unreasonably withheld, the likelihood
of completing the transaction diminishes.
It is best to retain an experienced professional to help you maximize the value of your company.
For more information, contact Paragon Ventures
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