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Purchasing A Business: What Is Due Diligence And When Must It Be Conducted?

What is Due Diligence?

For the prospective purchaser of a business, "due diligence" refers to the information gathering and evaluation process that every business purchaser must undertake prior to committing to a purchase transaction. This process must include active consultations and discussions with and between your business attorney and business accountant and must involve your evaluation (hopefully with the assistance of your business accountant or a valuation professional) of (a) the tangible assets of the business; (b) the real property interests of the business; and (c) the income and earnings potential of the business (also known as goodwill). Ultimately, a determination must be made as to whether or not the purchase price represents a fair value for the business that you are considering.

Timing of the Due Diligence Process

As a purchaser, you should be constantly gathering and evaluating information respecting the substantial investment that you will be making in the business. However, the reality is that the window for conducting this evaluation process is, in many instances, comprised of a short period of time during which you will be required to verify, process and evaluate significant amounts of data such as tax returns, financial statements, sales tax reports, purchase invoices and inventory reports. During the course of the purchase transaction, at a certain point - typically occurring just prior to signing a binding contract - your opportunity for due diligence will end and you will be required to commit to the purchase transaction.

Balance must be achieved between a seller's desire to maintain the confidentiality of his or her business information (sellers are especially concerned about unqualified purchasers and prospective purchases that are just "tire kickers" or, worse, competitors pretending to be a potential purchaser) and a purchaser's need to verify and evaluate the seller's information. To achieve this balance, as a purchaser, you will be faced with constant pressure from the seller to sign a purchase agreement and you will be left with the question of how do you agree to a contract without first verifying the seller's financial information and completing your due diligence evaluation. If you cannot complete your due diligence prior to contract signing (a difficult task that will require active communications with your business accountant and business attorney), it is my experience that the most practical solution - a solution that best protects the interest of a purchaser - is to proceed with signing a purchase agreement (thereby inducing the seller to release his or her information) that includes a "Due Diligence Contingency Clause". A due diligence contingency is, basically, a clause inserted into the purchase agreement that identifies a set time period during which the purchaser will be given access to the seller's books, records and business operations and be given an opportunity to conduct his or her due diligence. If, during the defined due diligence contingency period, the purchaser, for any reason (or however the criteria is defined by your business attorney), does not like what he or she sees, then the purchaser may cancel the contract.

If the seller will not agree to a due diligence contingency, then your evaluation must be completed prior to signing a contract and obligating yourself to any purchase agreement. If the seller insists on an agreement, speak to your attorney about a "due diligence contingency". So, before committing to a business transaction, it is critical that you speak to your attorney about the protection of your down payment and the steps that will be necessary for you to complete your review and evaluation of the business that you may be purchasing.




Charles N. Internicola, Esq., a partner at the Staten Island law firm of Decker Decker Dito & Internicola, LLP., is an experienced business and franchise lawyer who represents individuals and experienced business owners in business transactions and business litigation in Staten Island, New York City and New Jersey. Charles is the author of the book "An Entrepreneurs Guide to Purchasing a Business" and he is the editor of the New York Franchise Law Blog.  If you are involved in a business transaction, purchasing or selling a business, establishing a franchise system or involved in a business dispute, contact Charles Internicola to discuss the specialized legal services that he provides to his clients.

IMPORTANT DISCLAIMER: The information contained on this website is provided for general educational purposes only, should not be relied on as legal advice and does not serve to create an attorney client relationship. In utilizing this website you acknowledge that there is no attorney client relationship between you and Charles N. Internicola, Esq. and that the information contained on this site does not and cannot serve as a replacement for the competent legal advice of a licensed attorney in your state. The content of this website is subject to the Copyright of its author, Charles N. Internicola, Esq.

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