What due diligence steps you should take before acquiring a small business
Before you run, you should walk.
Not only true for busy toddlers, this adage also applies to small business acquisition.
If you’ve been thinking about a possible acquisition, whether to grow your business, start something new, or because an opportunity appeared in front of you, it could be great! But before you dive in headfirst, you’ll need to complete thorough due diligence to ensure it’s the right choice for you and your business.
There are many reasons you may benefit from acquiring a company, and you can even have multiple reasons:
- Getting into a new market
- Accessing advanced technology
- Supplementing your products
- Adding new personnel
- Growing geographically
- Growing market presence
- Diversifying product or service offerings
- Increasing supply chain pricing power
- Eliminating competition
When discussing the possibility of acquiring another business, the one big question is if the acquisition will provide direct value for you. There are a few ways to value a company, and of course, many layers of considerations.
The three main ways to assign value are:
- Take the net profits of the company, and multiply them by five. This is a very simple, general structure, but will give you a better idea of the company’s value. Remember, use actual profit, not revenue.
- Define the value of the physical assets – could be fleet vehicles, equipment, etc.
- Use a market approach by comparing similar companies within the marketplace to get a ballpark value. This can be hard to do with small businesses without public information.
Once you have a loose understanding of the value of the company, you’ll need to explore many more details as you begin walking the road to an acquisition.
Due Diligence Steps
- Is the company’s brand known for similar things as your company? Have you staked your reputation on customer service, communication, or product quality? Make sure the business you might acquire aligns in this way.
- What deal breakers are there for you and for the business you want to acquire? Talk about these up front so you know you’re on the same page.
- What are the market conditions and competitors of the company? Are they in a niche, or providing specific technology, expertise, or even patented processes or products?
- What value will they bring? Will they expand existing accounts, add new ones, or remove competition for you?
- Do you understand their vision? You need to know the company’s goals, strategy, and work ethic before you would consider an acquisition.
- Is there any ongoing litigation against the business? Do they have a history of litigation, especially one that exceeds reasonable occurrences for its size and industry?
- What do their investors think of interactions with the company? Are there any internal conflicts or other major conflicts you should be aware of?
- Do the services or products complement what you already offer?
- What are the ongoing costs for you and your staff? How will an acquisition affect your revenue and personnel costs?
- What kind of culture does the company have? Will it integrate with yours easily, or will there be confusion and lack of alignment?
- What do their books look like? A good candidate has clean, organized financial statements, which avoids unwanted surprises for you.
- What is the company’s reputation like online? Check out Glassdoor reviews if they exist, job listings, blog entries, news stories, their website, and online reviews – anything that can give you a thorough picture.
- Have you seen a comprehensive summary of the business? You should review three to five years of financial data, both profit and loss statements and a balance sheet, as well as any benefits offered and an outline of top customers.
As you continue your investigations, seek out assistance to pull together the detailed information you really need to be comfortable with a decision of this magnitude. Run background checks on the company and its key personnel to see if they’ve been the subject of any lawsuits or have any concerning criminal activity. Invest in a firm that can thoroughly review the company, reviewing their books, sales, and systems. If the business won’t allow you to do this kind of thorough review, they may not be the kind of company in which you want to invest.
You should also consider including a noncompete for any owners you’re buying out, and you should focus on more than just geography and duration for this. You can define a competing venture within the noncompete – you wouldn’t want to buy a company to then see the prior owner use the money to start a competing business.
These steps can seem overwhelming, but they are all key in discovering if an acquisition could be the right step.
You can get help to complete all the due diligence with a service like Gift CPA’s Acquisition Assistance. You’ll find the right experts to weed through the financial complexities as well as lead discussions on many related due diligence steps. If you’re ready to start the conversation, schedule an appointment with us today!