In the first in a series of monthly articles looking at best practices and issues facing business owners and prospective business owners, consultant Kumi Bradshaw of Asgill Post looks at the process of buying a business.

If you're now thinking of going into business for yourself, then you're most certainly contemplating what sort of business to start.

Entrepreneurship has its risks, but many of the challenges associated with starting a business from scratch can be avoided by purchasing an existing business. So, how do you know what kind of business to buy?

Perhaps you heard about the business through word of mouth or the media, or have had direct experience as a customer.

You may even work as an employee of the business or for a competitor. There are many options from which to choose, and the decision-making process can seem daunting.

However, as with any large purchase decision you make in life (buying a house or a car, for instance), you have to conduct the proper research in order to make an informed decision. In other words, once you believe that you have finally found the 'perfect' business to purchase, do your due diligence.

What is due diligence?

Due diligence is a structured research process, which can be separated into three distinct stages: identification, verification and assessment. I'm going to take you through these stages in order to give you a clearer picture of the research you need to conduct before buying a business.

Stage 1: Identification

This is where you, as the buyer, identify what you need to know in order to make an informed and responsible decision. You'll also decide how you'll go about gathering the information, and how much information you'll actually need. When assisting clients with due diligence, we start with a standard checklist.

The major areas that need to be examined in most business purchase transactions include:

1. Details of what is being sold: This is where you'll need to obtain important documentation such as an asset list and details of agreements impacting future operations (including contracts, gift certificates, etc.). Basically, everything you will receive or become responsible for if you take possession of the business.

2. Historical financial information: This includes Profit & Loss (P&L) statements, balance sheets, bank statements, point of sale records, contracts etc.

3. Operations documentation: How is the business currently operated? This includes manuals, customer lists, payment policies, and any other documentation you may need for day-to-day business operation.

4. Employee and Human Resources information: Any information pertaining to employees and management, including payroll lists, identification of those requiring work permits, job descriptions, and identification of key personnel.

5. Details of existing and potential obligations that could be inherited: These include government obligations (payroll tax, social security), outstanding accounts payable, potential lawsuits, contracts, etc.

Stage 2: Verification

In the verification stage of the due diligence process, you should ask yourself two basic questions:

1. Is all the information being presented accurate and truthful?

2. What am I missing? Is there additional important information that I haven't obtained? One of the first things buyers, the banks, investors and others look at when evaluating a business is its financial history. This is important for determining the worth and future viability of the business. What did the company gross in sales last year? How profitable was it? Are there any noticeable trends?

Despite the relative importance placed on this information, a surprising number of local businesses have inadequate financial records. Even where a local business may have complete financials prepared by a qualified accountant, records are seldom audited. As a potential buyer, what should you do? We recommend enlisting the services of a professional with a strong background in finance, particularly entrepreneurial finance.

Stage 3 : Assessment

Once the key details have been identified, and you feel comfortable about the integrity of this information (having verified it independently), the focus should turn to assessing whether or not your potential purchase makes sense. This is where you take all the information you have and analyse it, considering issues including the following:

1. The overall effect of a change in management/ownership.

2. Your relationship with employees and customers.

3. The capacity of the business to generate enough profit to pay down loans or other financial obligations.

4. The time and lifestyle demands of the business.

5. How much working capital will be needed to operate effectively.

6.The potential effect of external factors including competition, changes in the legal environment, changes in customer preferences, and market changes.

7. Your risk profile as a buyer and whether or not the purchase of this business matches that profile.

Keys to Success

Purchasing a business has its risks; but you can reduce this risk by conducting a thorough due diligence process. We recommend three keys for successful due diligence:

1. Use professional assistance where appropriate.

2. Communicate effectively with the seller, financing sources and anyone else involved throughout the process.

3.Work efficiently, but do not rush.

Good luck, and Caveat Emptor!

Kumi Bradshaw has a BA in economics and an MBA with a focus on entrepreurship and entrepreneurial finance. He is a Certified Business Appraiser (BBA) and a Business Valuator Accredited for Litigation (BVAL). Asgill Post provides business intermediary services: business valuation and M&A assistance. For comments or queries, contact Mr. Bradshaw at kumi@asgillpost.com