Whether you are fulfilling a life-long dream of owning your own business or expanding your existing empire, taking the time to properly conduct due diligence is a critical first step in purchasing a business and can determine whether you sink or swim.
Once you have identified a business you are interested in acquiring, purchasing a business in Hawaii generally takes one of three forms: 1) purchase of stock, if the business is a corporation; 2) purchase of membership interest if the business is a limited liability company (LLC); or 3) purchase of the assets and not the liabilities of a business through an asset purchase agreement. The asset purchase agreement is the most common. Before making an offer on a prospective business, it is good practice to learn the basics of the industry, the necessary equipment, materials, and skills required to run the business, the reputation of the business, and some idea about its current sales and customer base. After some initial discussion and negotiations with the owner about the business, price, and terms, you will need to make a written contingent offer to buy the business in which completion of the transaction is contingent upon your due diligence investigation. But what is due diligence?
Due diligence is a term of art that can be broadly defined as that phase in the purchase of a business when you: 1) verify the accuracy of the information you’ve previously been provided by the seller, and, 2) make sure there are no serious undisclosed problems with the business. You should make your due diligence period as long as you reasonably believe you will need to do a thorough investigation.
Following the seller’s acceptance of your written contingent offer, he or she will then likely require you to sign a Non-Disclosure and Confidentiality Agreement (NDA), prior to conducting your due diligence investigation. An NDA will allow you to see the seller’s books and records but not make excessive copies or transmit them to unrelated third parties. An NDA may also restrict your ability to use certain information, such a customer lists or trade secrets, in case the sale does not close.
Once you begin due diligence, you are entitled to and should inspect all the books and records for the business, including not only profit and loss statements, which you may have already been provided, but also tax returns, bank statements to verify deposits, monthly sales tax reports if there are issues relating to sales revenue or seasonality of sales during different times of the year. You may also ask to review quarterly payroll reports if you have questions about wages. This is not a time when shyness is rewarded. Be sure to ask the seller for any clarification or assistance you need in interpreting the financial records.
Other relevant points to include during due diligence are inspection of all equipment and/or vehicles to ensure they are fully operational (I once had a client who had purchased a bakery without inspecting the oven, only to find it did not work after closing. This obviously delayed their opening and added significant, unplanned cost) the transferability of warranties or service agreements, product inventory, customer lists, inquiries about key employees, the transferability of any leases for space, and, legal, regulatory or environmental issues that may apply to any leased space.
Remember, in an asset sale, you are only purchasing certain assets of the business and assuming none of the liabilities. That said, your due diligence investigation should also include any outstanding legal issues to make sure they are resolved to your satisfaction or will be prior to closing.
Hopefully, everything will check out in your due diligence phase (fingers crossed) and you will be one step closer to acquiring your business.
For help in acquiring a Hawaii business, or to learn more, call Emily A. Gardner, Attorney at Law, LLLC at 808-727-1220.