Due diligence points to focus on before you buy a business in NZ

For prospective buyers, this represents a great opportunity to purchase successful businesses, but it also comes with risks. Just as you wouldn’t buy a home without a builder’s report, purchasing a business without thorough due diligence can expose you to hidden issues and costly surprises. The due diligence process is an essential step to ensure you make an informed and sound investment decision. 

It is recommended that you seek professional advice during this process. It is the job of your advisor to ask the hard questions, challenge assumptions and help you see the full picture. As a potential business owner you might be caught up in the excitement of the future possibilities. It is easy to overlook red flags or make decisions based on emotion not facts. 

Your advisor’s job is to question and audit your thinking to ensure you are not buying a dream but making a good investment decision. They are there to help guide you and offer professional assistance, although it is ultimately up to you to understand and review the operational risk of your business purchase. A thorough due diligence process can be the difference between a successful acquisition and a costly mistake.

 The risk will depend on the size, industry and structure of the business you are looking to purchase. Here are some of the main considerations in a due diligence process: 

• Financial health of the business – This includes reviewing historical financial statements and assessing the business’ profitability, cashflow and working capital requirements. It’s important to sense-check the information, note drops in revenue or increased expenses, and drill down to identify any financial risks. Keep an eye out for any unusual one-off transactions or unusual financial processes that might distort the profit figure. Also be aware of any differences in how you would operate or finance the business and assess profitability and serviceability of the business with this in mind. 

• Legal and regulatory requirements – Understand and review what contracts are in place, such as lease, supplier and employment agreements. Make sure key contracts with customers can be transferred to you, especially if they are government or council contracts. Ensure that there are no pending issues, such as litigation or compliance problems, that may come to fruition and impact your brand or business. Check whether there is any intellectual property owned by the vendor and if it can be transferred to you. If you are buying the shares in a company, rather than buying the business, further due diligence is required as you are taking over the history of that entity along with the assets and liabilities. 

• Operational review – You need to understand key processes and systems, and identify any reliance on key individuals, especially if one of them is the vendor. Make sure that tasks currently handled by the vendor are documented or known to another team member, or that a plan is in place to transfer the knowledge during the transition period. You should also review the staff structure, their roles and employment agreements. Employment agreements do not automatically transfer to the buyer in an asset sale. You can offer new employment agreements to any or all of the staff. These might be the same as or similar to the previous agreements, but that isn’t necessary unless specified in the sale agreement. However, if you are buying the shares of the current company, the legal entity remains the same and therefore employees continue under their existing contracts. 

• Customer and supplier relationships and competitive landscape – It is important to ascertain the composition of customers and reliance on any particular customer. It is equally vital to review existing contracts and understand if there is any risk of a customer leaving. Also identify any customer relationships with the vendor (such as family or friends) that may have special rates or contract terms. Review supplier terms and reliability, and understand the business’s market position and who its main competitors are, along with any threats to operation. 

• Asset and liability review – Verify assets that are part of the business sale and make sure their value matches their condition. Review any maintenance and service registers to ensure that the assets have been kept in good condition, and check whether there are debt obligations on any of them. Check inventory levels and valuation of stock, and also review any stock that you may not want to take over, for example, if it’s old or slow to turn over.

• Value and deal structure – It’s a good idea to ask your accountant how best to structure the purchase and the factors that affect value prior to confirming price. There are numerous items that can affect this.

• Future potential – Assess opportunities for growth and potential for scalability. Understand industry trends, economic outlook and technological risk in terms of long-term changes to the industry. Consider where your skills, experience and resources fit within the business, and what you may need assistance with. Success comes when it is the right fit for you. 

Buying a business is one of the most significant decisions you will make and it deserves careful planning and expert guidance. A thorough due diligence process, supported by experienced advisors, will help you to make informed decisions and avoid costly surprises, and set you up for long-term success. 

If you are considering buying a business, our business advisory or corporate advisory teams can guide you from the outset. We look forward to hearing from you!