A “Pig in a Poke” – The Importance of Due Diligence
Once a buyer has negotiated a deal and secured the necessary financing, he or she is ready for the due diligence phase of the sale. The serious buyer will have retained an accounting firm to verify inventory, accounts receivable and payables; and retained a law firm to deal with the legalities of the sale. What’s left for the buyer to do is to make sure that there are no “skeletons in the closet,” so he or she is not buying the proverbial “pig in a poke.”
The four main areas of concern are: business’ finances, management, buyer’s finances, and marketing. Buyers are usually at a disadvantage as they may not know the real reason the business is for sale. This is especially true for buyers purchasing a business in an industry they are not familiar with. The seller, because of his or her experience in a specific industry, has probably developed a “sixth sense” of when the business has peaked or is “heading south.” The buyer has to perform the due diligence necessary to smoke out the real reasons for sale.
Business’ Finances: The following areas should be investigated thoroughly. Does the firm have good cash management? Do they have solid banking relations? Are the financial statements current? Are they audited? Is the company profitable? How do the expenses compare to industry benchmarks?
Management: For a good quick read on management, the buyer should observe if management is constantly interrupted by emergency telephone calls or requests for immediate decisions by subordinates? Is there a lot of change or turn-over in key positions? On the other hand, no change in senior management may indicate stagnation. Are the employees upbeat and positive?
Buyer’s Finances: Buyers should make sure that the “money is there.” Too many sellers take for granted that the buyer has the necessary backing. Sellers have a perfect right to ask the buyer to “show me the money.”
Marketing: Price increases may increase dollar sales, but the real key is unit sales. How does the business stack up against the competition? Market share is important. Does the firm have new products being introduced on a regular basis.
By doing one’s homework and asking for the right information – and then verifying it, buying a “pig in the poke” can be avoided.