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Due diligence when buying a business

Starting your own business is always a risky proposition -- but buying an established business isn't always safe either.

When you purchase a business, the ultimate rule is, of course, "buyer beware."

You have to perform a certain amount of due diligence in order to verify that the seller is disclosing everything important. That's really the only way that you really know what you're buying.

In order to perform your due diligence, you need to send the seller a letter of intent:

  • It sets the time period during which the seller has to turn over the requested information.
  • It sets the time period you have to review the information.
  • It lists all of the information you need the buyer to either provide you with or make available.

While this isn't an exhaustive list of the documents that you'll need to review, it's important to pay attention to the following broad areas:

  1. The company's organizational paperwork, bylaws, amendments and records of shareholders (if any).
  2. The company's financial and tax records. You need at least three years of financial records plus the information from the current year. You also need things like the auditor's reports, inventory schedules, budgets and projections.
  3. A record of all physical assets -- including those that are merely leased. Make sure that you get copies of the leases or sales purchase receipts. Real estate records should also be included.
  4. Intellectual property may be particularly important, depending on what business you are buying. Records of all patent holdings, patents pending and copyrights are necessary when evaluating a company's holdings.
  5. Employee names, contracts, personnel handbooks and an organizational structure helps you understand the internal structure of the business.

It's also important to make certain that you know about the potential liabilities you may face when you buy the business. When you buy the business, you also buy its problems.

Make certain that you get copies of any pending lawsuits filed by employees or former employees for discrimination or wrongful termination. You also need records of workers' compensation claims and litigation that's pending.

If there's no litigation pending against the company (which is ideal), ask the seller for a letter from his or her legal counsel confirming that fact.

Keep in mind that you can never be too thorough when doing your due diligence.

Source: FindLaw, "Buying a Business: Due Diligence Checklist," accessed Dec. 08, 2017

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