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Buying a Business: Forget Trust – Understand Due Diligence

Buying a Business: Forget Trust – Understand Due Diligence

According to the U.S. Bureau of Labor Statistics, over 50% of start-up businesses fail within five years. This is a staggering statistic and one that should bring concern to anyone seeking to start a new business venture.

An alternative to starting a new business is to purchase an existing establishment. This option, if all goes right, can significantly decrease the risk factor and increase the chance of success. However, nothing is for certain. Someone seeking to buy an existing business should first question why that business is for sale in the first place.

Understandably, there are several reasonable reasons why a business would be for sale: death of owner, retirement, owner moving, or an unfortunate sickness. In these situations, the business transaction consummates with satisfied and mutually agreeable parties on both ends. But then again, there exists unscrupulous reasons, which are sometimes disguised by the familiar “owner retirement” or “owner sickness” announcement to simply lure potential buyers into a trap of deceitful and fraudulent circumstances. The desire of some business owners to fraudulently sell their business to another could be the result of pure deception and greed, or because the business is not producing the revenues it once attained.

Business transactions, especially ones involving small businesses, periodically occur between friends and family members. These could be the most disastrous, since the buyer’s initial sense of security and trust might turn out to be only a figment of the imagination. The old well-known quote from President Ronald Raegan that states, “trust, but verify!” could be the most powerful thought when acquiring an establishment from a friend or family member.

So, is there protection against being casted on the next episode of “American Greed”? In reality, no! However, there are precautions that a potential buyer can implement to help protect his or her investment and safeguard against being defrauded out of large sums of money.

I am sure you have all heard the term “due diligence”. But, how many of you actually understand the importance of, and the consequences surrounding, such a term? Due diligence came into being when the U.S. Securities Act of 1933 was passed. Securities dealers and brokers became responsible for fully disclosing material information related to the instruments they were selling. Today this term surrounds most mergers and acquisitions of large corporations, and also impedes on the business transactions of small organizations and businesses.

Essentially, due diligence is a thorough and detailed investigation or audit of a potential investment to confirm all material facts related to a sale, such as reviewing all financial records, plus anything else deemed material to the sale. This could include ensuring there is working equipment, an investigation of liens and loans, outlining personnel concerns, and a thorough and detailed review of accurate accounting records.

The overall value of the small business can also be derived from the due diligence findings. Financial and accounting records could be the most important concern for small business purchasers in determining the health of the business. Those sellers attempting to simply “unload” the business will inevitably be tempted to convey falsified, or at very least modified, revenues and expenses to increase the attractiveness and value of the business.

The first step to ensuring a smooth and successful small business purchase is to eliminate the word “trust” from your vocabulary. As stated, the notion of family and friends has no place in business transactions – it’s simply business! Second, hire two important individuals: a lawyer knowledgeable in small business transactions, and an experienced accountant. These individuals will greatly assist in the due diligence required to determine if the seller is really that trustworthy long-time friend, or simply a greedy, untrustworthy, and deceitful “shark” seeking to gain monetary advancement off of your gullible trust.

Invest the time and money required for due diligence upfront, since the battle to regain your initial investment may be one you can win, but it will also be costly and stressful.

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by Jeff Belsky MBA, D.B.A. // Dr. Jeff Belsky holds an MBA and a Doctorate Degree in Business Administration (DBA). He is a Vice President of Strategy for an organization in Pittsburgh, and a Certified Executive Leadership Coach with Solutions 21, an international organizational development company located in Pittsburgh, PA.

Opinions expressed by contributors are their own.