The Importance of Due Diligence Before Making Business Purchases

When considering the acquisition of a business, thorough due diligence is essential to ensure that you are making an informed decision. As a CPA firm, we provide comprehensive due diligence services that help uncover potential risks and verify the financial health of the target business. Below are ten critical aspects of the due diligence process for business purchases that we emphasize to our clients.

1. Tax Implications of the Purchase Structure

• Entity vs. Asset Purchase: Understanding the tax implications of purchasing the entity (stock purchase) versus purchasing individual assets.
• Entity Purchase: Potential assumption of existing liabilities and less favorable tax treatment.
• Asset Purchase: Ability to step up the tax basis of assets, leading to higher depreciation deductions.
• Section 338 Election: Consideration for treating a stock purchase as an asset purchase for tax benefits.

2. Verification of Financial Statements

• Accuracy of Financial Records: Ensuring that the balance sheet, income statement, and cash flow statements accurately reflect the business’s financial position.
• Reconciliation: Cross-checking financial records with bank statements, tax returns, and other financial documents.
• Red Flags: Identifying unusual transactions, discrepancies, or trends that may indicate financial instability.

3. Review of Existing Liabilities

• Current and Long-Term Liabilities: Detailed examination of all existing debts and obligations, including accounts payable, loans, and deferred income.
• Contingent Liabilities: Identifying potential future liabilities that may arise from pending litigation, warranties, or guarantees.

4. Assessment of Future Costs

• Maintenance and Upgrades: Projecting future costs for maintaining and upgrading facilities and equipment to meet operational standards.
• Compliance Costs: Estimating costs associated with complying with regulatory requirements and industry standards.
• Insurance and Indemnity Obligations: Reviewing current insurance policies and potential costs for future coverage and indemnification clauses.

5. Examination of Tax Returns

• Historical Tax Returns: Reviewing the last three years of tax returns to verify reported income, expenses, and compliance with tax laws.
• Sales Tax Reports: Ensuring accurate reporting and payment of sales taxes, particularly for businesses with significant retail operations.

6. Evaluation of Key Contracts and Agreements

• Franchise Agreements: Reviewing terms of franchise agreements, including renewal conditions and any associated fees.
• Lease and Vendor Contracts: Assessing the terms of key leases and contracts to ensure they are favorable and transferable.
• Noncompete Agreements: Evaluating the terms and enforceability of noncompete clauses.

7. Inventory and Asset Valuation

• Inventory Levels: Verifying the accuracy of reported inventory levels and assessing the quality and turnover rates.
• Fixed Assets: Ensuring proper valuation and condition of fixed assets, including buildings, equipment, and vehicles.
• Intangible Assets: Assessing the value of intangible assets like goodwill, trademarks, and customer lists.

8. Role of the CPA

• Financial Verification: Providing a thorough examination of all financial records to ensure accuracy and completeness.
• Tax Planning: Advising on the most tax-efficient structure for the transaction and ensuring compliance with all tax laws.
• Future Financial Projections: Assisting in projecting future financial performance and potential costs.

9. Role of the Attorney

• Legal Compliance: Ensuring that all aspects of the transaction comply with relevant laws and regulations.
• Contract Review: Reviewing and negotiating the terms of purchase agreements, leases, and other key contracts.
• Risk Mitigation: Identifying and mitigating legal risks associated with the transaction.

10. Environmental and Regulatory Compliance

• Environmental Liabilities: Identifying any potential environmental issues, particularly for businesses with physical locations or manufacturing operations.
• Regulatory Requirements: Ensuring compliance with industry-specific regulations, including health and safety standards.

Conclusion

Due diligence is a critical step in the business acquisition process. It helps uncover potential risks, verifies financial health, and ensures that you are making a sound investment. By leveraging the expertise of a CPA firm and legal counsel, you can navigate the complexities of the transaction with confidence and make informed decisions that align with your strategic goals.

Our CPA firm specializes in providing comprehensive due diligence services tailored to your needs. Contact us today to learn how we can assist you in making your next business purchase a success.