In last week’s post we discussed the legal issues surrounding due diligence. This week we continue our Purchase and Sale of a Business series and due diligence series by discussing some essential financial issues to consider during the due diligence phase of purchasing a business.
Avoid a Headache; Know the Financials In and Out
The last thing you want to do is purchase a company with disorganized books and a lack of financial records. Not only will you spend time and money sorting out the books and reconciling the financial records, you’ll also likely inherit “surprise debt” or other financial liabilities. By taking the time to review the company’s books and learn more about its financial condition, you’ll avoid a headache or two down the road.
If you’re the seller, there are some things you can do in advance to be a more attractive investment opportunity and to make things easier during the due diligence process. A prepared seller will have cleaned up the company’s books, organized its financial reports, and put together a comprehensive folder that details the company’s financial condition. The best practice is to complete your own set of due diligence prior to finding a buyer.
I’ll be the first person to admit that reviewing financial statements and accounting reports is not exciting. Often, these number-laced documents send readers into a sudden coma after just minutes. Luckily, there are experts out there that actually enjoy reviewing financial statements, balance sheets, and accountants’ reports. They’re called (fittingly) accountants. It’s worth the money finding the right CPA to work with during the due diligence phase of purchasing a business.
When you look into the financial condition of the company, you’ll want to make sure that the company does not have any significant tax liabilities. Has the company filed regular tax returns? Has the company paid payroll taxes to the government? Are there any outstanding tax payments that are owed? These are some of the questions you should find answers to during due diligence. It’s surprising how many businesses choose to neglect mandatory tax requirements; the penalties for ignoring these tax requirements can be significant.
It is also important to determine whether the target company has provided loans to its employees. Sometimes, the promissory notes are extended to officers to enable the officers to purchase company stock and start their capital gain holding period with respect to such stock. The promissory notes should be reviewed to determine the recourse nature of the notes and the interest rate that applies. Also, under the Sarbanes-Oxley Act of 2002, loans are prohibited to public company officers. Therefore, the buyer will need to make sure to review carefully any outstanding loans to individuals that may or will become officers of the target company post-acquisition.
If you’re interested in learning more about financial issues you should be aware of when purchasing a business, please feel free to contact us today to schedule your free consultation.