What is ‘formal due diligence’ and when should it start?

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Every buyer conducts due diligence before purchasing a business.  In a general sense, this means that a buyer will investigate the business they are seeking to acquire. But what is ‘formal due diligence’? When should it start? When does it normally start? Let’s dive in with Martin at Five Star Business Brokers of South Florida and answer these important questions.

The buyer normally first learns about a business through a confidential advertisement or some kind of a ‘teaser’ seen online. After qualifying oneself and signing a non-disclosure statement, Five Star Business Brokers of South Florida then gives a buyer the comprehensive and confidential listing package about the business.

Simply by being told the name of a business, buyers today can investigate quite a bit simply through internet searches (think restaurant reviews).  They can also use the internet to investigate competitors and conduct demographic about industry dynamics for the subject business.  Many other confidential details about the lease, financials of the business, and how the business operates. Then if interested further, a face to face meeting or conference call is arranged. Here, Martin at Five Star Business Brokers of South Florida will ensure the buyer’s questions are asked properly and answered as clearly as possible. Sometimes at this point a buyer will make an offer. Sometimes at this point the buyer may then request more information.

The ‘formal due diligence phase’ starts at the point when the seller no longer wishes to release information to the buyer unless there is a signed letter of intent or purchase contract (typically followed by a refundable deposit held in escrow). The seller usually will not release super-confidential information (such as bank statements or W2 forms) until knowing that these safeguards are in place. The reason of course is that the seller wants to make sure the buyer is serious and there is a meeting of the minds on the basic terms of the deal. Additionally, costs are a factor. The seller will usually have fairly legal and accounting costs, as well as their own personal man-hours of complying with the due diligence request. So peace of mind is a must for most sellers before undergoing ‘formal due diligence.’ ‘Formal due diligence’ is sometimes described in the letter of intent or purchase contract. It varies widely by industry and by choice of the parties to the deal. It can consist of releasing more detailed financials than previously given to the buyer, bank statements, payroll records, insurance certificate, copy of lease, and allowing the buyer to ‘observe’ the business for a period of time.

‘Formal due diligence’ normally occurs after a letter of intent is signed. But sometimes the parties agree to wait until a purchase contract is signed before commending formal due diligence. In Martin’s experience at Five Star Business Brokers of South Florida, his observation is that the parties should always start formal due diligence as soon as a letter of intent is signed. The main reason is that the parties will avoid costly legal fees if ‘formal due diligence’ results in the buyer pulling out of the deal. Moreover, it is always best to get moving and start with the ‘formal due diligence’ as soon as possible because it will shorten the overall time that the deal is ‘under contract.’ When deals are ‘under contract’ (including when they are ‘under a letter of intent’), sellers may not solicit other offers. This can cause serious problems to the seller and is best left avoided by all.

Located in Palm Beach County, Florida, Five Star Business Brokers proudly transacts business sales throughout the areas of West Palm Beach, Lake Worth, Palm Beach Gardens, Boca Raton, Jupiter, Delray Beach, Boynton Beach, Wellington, Palm Beach, Royal Palm Beach, and Riviera Beach.

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