Due Diligence: How to Uncover Problems Before You Buy a Business in NJ
Due diligence is probably the most critical stage when buying a business. Many prospective buyers for some reason limit themselves during this period to strictly a financial analysis, but due diligence goes far beyond that. Due diligence requires you to undertake a complete investigation of the entire business.
One of the keys to buying a profitable business is discovering and understanding the intimate details of the business: its strengths, weaknesses, pluses, minuses, growth opportunities, and areas of operation. If you do not perform a detailed due diligence examination by gathering exhaustive and potentially diverse information, you enter into a transaction “partially blind” and at your own risk!
Start Your Due Diligence By First Creating a Checklist
You must make sure to uncover as much as you can reasonably find about the business BEFORE you buy it. You do not have to meet the seller or visit the business for your research. The Internet is an incredible tool that will allow you to investigate the business, the industry, the competition, the marketing, the suppliers, and on and on.
Your priority items are going to include the examination of organizational records, general financing, accounting information, and other material agreements.
Organizational records include copies of the filed business charter that establishes the legal status of the business in New Jersey. Examples of the business documents that should be obtained and examined include the certificate of incorporation, any written or verbal shareholders agreement(s), LLC membership agreement(s), the certificate of partnership formation, and any written and partnership agreement(s). Additionally, a list of any modifications to these documents as well as a certificate of good standing issued by the secretary of state are essential.
A buyer will also want to review the minutes of shareholder/LLC meetings and/or the board of directors for at least the last several years if the business and/or purchase price is large enough. A buyer will also want evidence of authorizations necessary to lease real estate to all business locations.
The buyer should be aware of the management of the company, including a list of persons who are granted daily management powers and would include persons having powers to represent the company.
As for general finance and accounting information, the buyer should get documents evidencing borrowings of the company such as loan and credit agreements, promissory notes, mortgages or lines of credit; any bank letters confirming lines of credit, any pledges liens or other security interests on any assets of the company, any subsidies, premiums, investment incentives or other grants from national municipal or government authorities; any commitments of the company for the benefit of third parties which would include loans or guarantees and/or security interests.
It is also important to note documents that have evidence of any advances or loans made by the company to its shareholders or directors.
Material Agreements
There will be other material agreements that are going to be essential to deciding whether a buyer will want to purchase a company. Some of those material agreements include contracts and arrangements between the company and any present or former owners, employees, officers or directors.
A buyer will want information on all contracts that last at least one year, or cannot be terminated without penalty, or have a value or requiring the expenditure of at least $10,000. A buyer will also like a list of the top 20 major customers and the top 20 major suppliers of the company, copies of all contracts/forms used by the company as standard service or purchase contracts, all agreements entered into the company in the ordinary course of business.
A buyer will also want all insurance policies, casualty, liability, title and workers compensation insurance, as well as all marketing sales, distribution and franchise agreements, and a list of any independent salespersons or distributors. Non-compete agreements and confidentially agreements that the company has entered into, all material supply or requirements contracts to which the company is a party.
A buyer will also want to find copies of agreements of all independent contractor consulting, agent service, purchase marketing, broker advertising contracts to which the company is a party. The company should also be able to provide standard form purchase orders, sales agreements or invoices.
Ancillary Checklist Items
There are some second priority items that any purchaser of a company might want to review. Those documents include any kind of litigation, employment matters, commercial arrangements, real estate, equipment permits, and intellectual property; as well as federal and local taxes and several other miscellaneous items. With regards to litigation, a buyer should get a copy of all pleadings and order judgments related to litigation or arbitration involving the company for the last five years.
For employment matters a buyer will want all applicable collective bargaining agreements, copies of the company’s standard employment contract for each category of employment, copies of bonus, profit sharing, and deferred compensation plans; as well as material employment contracts and standard employment related agreements which include a confidentiality agreement, invention assignment agreements, conflicts of interest, declarations and non-compete agreements.
A buyer should also acquire knowledge of all pending or threatened legal actions that were filed on behalf of employees during the last three years and any significant correspondence with labor and social security authorities for the last three years.
A Couple of Things to Keep in Mind…
Allow yourself enough time:
Many sellers insist on a very short inspection period; sometimes just days. Don’t get pressured into this – give yourself enough time to complete this process. You should not settle for less time than you comfortably need to complete a thorough inspection/due-diligence period. A financial review can usually be done in days (except around April 15th if you plan on retaining an accountant) but there is more to investigate and that is why a 30-45 day due diligence period is not unreasonable for larger businesses, while a 30 day period (in my opinion) is reasonable for a smaller business to move the deal forward to a successful closing.
Fredrick P. Niemann Esq.
Do you have a question(s) about the due diligence process as part of buying a business in NJ? If so, contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com to schedule a consultation about your pre-business purchase questions. He welcomes your calls, inquiries and in-office consultation and you’ll find him very approachable and easy to talk to.
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County New Jersey Buying a Business Attorney