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This is the final article on conducting a due diligence review when purchasing a business. This article lists relevant records, contracts, financing and credit arrangements, and brokerage commissions relevant to the transaction.

VI. Administrative Records.

Administration includes all of the procedures, policies and records related to the day-to-day operations of the company. A well-run company keeps good, thorough, accurate records. You will need to review copies of all the administrative records, including:

1. All current contracts with suppliers. Do any of the contracts require written notice if control of the company changes?
2. All current contracts with consultants, independent contractors, commissioned sales people, etc.
3. Details of trade and accrued liabilities, including payment terms.
4. Inventory valuation, turnover and obsolescence review.
5. Details of bank indebtedness and long-term debt.
6. Insurance coverages - who or what covered, amounts, names of insurers: key man, life, health, liability, property, business interruption, product liability, etc.
7. Insurance claims incurred but unreported.
8. Credit reports.
9. General, administrative and factory overhead.
10. Backlog and order records.
11. Pricing policies.
12. Bank accounts.
13. Government and non-government financial assistance.
14. Trade association memberships, club memberships, etc. - amounts, due dates, benefits.
15. Non-competition, confidentiality and nondisclosure, non-circumvention agreements.
16. Management organizational chart, list of managers and department heads and functions of each.
17. Employee handbooks, guidelines, workplace policies and bulletins, occupational health and safety guides.
18. Employment contracts, key personnel files, confidentiality and indemnification agreements.
19. Vacation plans, bonus payments, benefits packages, severance pay policy, early retirement options.
20. Labor union agreements and recent negotiations.
21. Worker's compensation, insured and self-insured plans.

ASSETS AND LIABILITIES

VII.    Property.

Get a list of all property (real and personal) owned or leased by the business, and review all documentation related thereto.

Real Estate

1. Description, location and character of all real estate property owned by the business.
2. Surveys, appraisals, certificates of title, title opinions, title insurance, and inspection reports. Consider whether an inspection is required.
3. Liens for taxes or assessments (if any).
4. Mortgages registered against property owned by the business.
5. Zoning restrictions.
6. For all leased real property, name of landlord, location and condition of premises.
7. Lease provisions, particularly:
   • amount of rent,
   • type of lease (e.g. net lease),
   • permitted use,
   • services and amenities included,
   • right to sublease or assign,
   • actions constituting breach or default,
   • registration of leasehold interest on title.

Tangible Personal Property

1. List of all machinery and equipment owned, leased or on order, including motor vehicles, manufacturing plant, computer systems, data processing and communications systems.
2. Details of all fixed asset purchases and a schedule of depreciation.
3. Conditional sales contracts, chattel mortgages or other liens.
4. Terms of leases:
   • payments,
   • expiry dates,
   • renewals (automatic or requiring notice),
   • buy-out options,
   • replacement and repair provisions,
   • breach and default,
   • discharge of lessor's security interest on purchase by lessee.
5. Service agreements.
6. Computer security and disaster recovery procedures.

Intangible Personal Property

1. Patents, copyrights, trade names and trade marks (domestic and foreign).
2. Nondisclosure agreements, trade secret agreements.
3. Business licenses.
4. Other licenses for company or employees.
5. Ownership of subsidiaries (shares, partnership, other).

VIII.    Financings.

Review all loan and credit agreements, and any other documentation evidencing material borrowing, including:

1. Promissory notes.
2. Letters of credit.
3. Guarantees.
4. Line of credit agreements.
5. Sale or lease-back arrangements.
6. Installment purchases.
7. Correspondence with lenders for the past 3 years (or less, if the company hasn't been in existence that long).
8. Any business conduct restrictions, restrictions on acquisitions or mergers, due on sale clauses.
9. Conditions of breach or default.
10. After-acquired property clauses in mortgage documents.
11. License, franchise and royalty agreements.

IX.    Broker.

Lastly, is there a broker involved in the purchase and sale transaction? Who is the broker representing? If you're liable for paying any portion of the broker's commissions and other costs, you must have a copy of the broker agreement.

Once you have had a chance to answer all of the questions and review all of the materials listed in these last few articles, you should know all you need to know to determine whether to go ahead with purchasing the business. If you and your lawyer and accountant are happy, it's time to negotiate the Purchase and Sale Agreement. Good luck with your acquisition!

In our last post we discussed the importance of a due diligence review when you're considering purchasing a business, and covered the questions that should be answered with respect to the business' financial and corporate history. This week we talk about legal and regulatory matters, customers, goodwill, market share and potential for growth.

Today we start a 3-article series on how to conduct a due diligence review when you are considering buying an existing business. Part I of the series covers the financial, corporate and historical data you should look at with your accountants and your lawyer. If you're thinking about purchasing a business, there are many issues you need to consider and many documents you need to review with your legal and financial advisers before you close the deal. It's not only important to know the current status of the business, but also its past history, its long-term viability, future market opportunities, and potential for growth.

This is a question that we get asked frequently, so it seemed like a natural topic for a blog post. Let's do a comparison of the two structures.

Formation and Duration

A partnership is a business entity that is not registered as a corporation or a limited liability company and which is owned and carried on by two or more parties for the purpose of generating profit for the partners.

A joint venture or (JV) is formed when two or more parties join together to take on a specific project. The parties share the costs and the risks, as well as any gains and benefits, and contribute money, property, effort and know-how to the venture.

While a joint venture is usually set up for a fixed time frame (i.e. the life of the project), a partnership is typically long-term and is intended to carry on as long as the partners want to continue doing business together.

Participants in a JV do not usually intend to conduct a common business with the other co-venturers, and they're free to carry on their own businesses outside of the business of the JV. Partners in a partnership, on the other hand, are typically already carrying on their business within the context of the partnership (for instance, attorneys or accountants).

Participants' Contributions to the Business

Participants in a joint venture are required to contribute money, property, expertise, knowledge, time and other resources to be used by the joint venture. They are also entitled to receive a percentage of the revenues or proceeds from the business of the joint venture in proportion to the resources they contribute.

In a partnership arrangement, the partners may also contribute money, property, know-how, and other resources to the partnership, but they are not required to do so. Partners are also entitled to a commensurate share of the profits from the partnership.

Partners usually intend to treat any property contributed to the partnership as partnership property. In a joint venture, the property contributed by the co-venturers is returned to each of them when the joint venture is wrapped up unless it has been sold to the other participants.

Management of the Business

The day-to-day business of a joint venture might be carried out by one co-venturer on behalf of all of them, but usually major strategic and operational decisions will require the consent of all the participants and cannot be made by one co-venturer as agent for the rest. This helps to ensure that the participants have mutual control.

In a partnership, mutual control is not always a consideration. Sometimes only particular partners (such as senior partners in a law firm) have management roles. And a general partner can act as the agent for all other partners and can transact business and enter into contractual obligations and debts without the consent of the other partners.

Risks and Benefits of Each Type of Entity

Image by Gerd Altmann from Pixabay

There are risks in either type of relationship and it is important that you have a good level of trust in the people you are partnering or venturing with. Do some background checking on the other parties to make sure you feel comfortable about entering into a relationship with them.

• A partnership can incur obligations on its own account (much like a corporation) but a joint venture cannot - only the participants (co-venturers) can sign contracts and incur debts.
• In a partnership, each partner is jointly and severally liable for the debts and obligations of the partnership, with the exception of limited partnerships, in which the limited partners' liability is capped. In a joint venture, each participant is liable only to the extent of its interest in the JV.
• As for benefits, a partnership operates on the expectation that it will produce profits for the partners. That is the chief benefit that all of the parties work towards. The benefits of participating in a joint venture, on the other hand, may be tangible (such as development of a real estate property) or intangible (such as R&D of a new manufacturing process).

Tax Considerations

There are significant differences between the way taxes are calculated for joint ventures vs. partnerships, and tax laws vary from country to country. International ventures must also be aware of the rules governing their business under existing or future double tax treaties. Obtain the services of a tax consultant who knows the tax laws for partnerships / joint ventures in your own country and in any other country you're going to be doing business in.

For legal purposes, neither partnerships nor joint ventures are considered corporate entities separate and apart from their participants. But for income tax purposes, the net profit or loss of a partnership (i.e. expenses, capital cost allowances, etc are deducted) is calculated before a share of the net profit or loss is allocated to each partner, even though the partners will be taxed on that allocation. In a joint venture, the gross revenues / production, expenses, and capital receipts and outlays are allocated among the co-venturers based on their respective interests, and each of the participants then calculates its own net profit or loss and tax payable.

Selling or Transferring a Partnership or JV Interest

The transfer of a partnership interest typically requires the consent of the other partners. And because the partners generally have an indirect interest in the property and assets of the partnership, a partner can transfer its interest in the partnership itself but NOT its interest in the partnership assets. The partnership retains the beneficial interest in the partnership assets as long as the partnership is in operation, and the partners will not be entitled to a share of the net proceeds from those assets until the partnership is dissolved.

In a joint venture, the co-venturers retain their individual ownership of the property they have contributed to the joint venture, so they have full control over the contributed property. This means that the assets of the joint venture are not owned jointly by the co-venturers, and typically a co-venturer would be able to sell its interest without obtaining the consent of the other co-venturers (subject to any rights of first refusal the other participants may have under the terms of the Joint Venture Agreement).

A partnership interest is generally considered capital property for income tax purposes, and the sale of that interest would result in a capital gain or loss. An interest in a joint venture is not considered capital property and is taxed on the same basis as the sale of an interest in each of the assets of the venture.

Death of a Participant

Since a joint venture is usually limited to a single project or undertaking and only exists for a finite time, the death of one of the participants will not normally terminate the joint venture (unless the joint venture contract is a personal service contract), whereas the death of a partner has a significant impact on a partnership and may well mean the end of the partnership.

Put It In Writing

Whether you're setting up a partnership or joint venture, Do Your Research and get legal and accounting advice before you start. The participants should then put together a written agreement which clearly defines the terms of the relationship, the responsibilities of each of the participants, a procedure for transferring a party's interest, and a mechanism for terminating the agreement.

A written agreement is required if you intend to make a joint venture election for tax purposes. It is important to agree in writing as to the value of each participant's contribution of capital and resources, and to specify the proportionate interest of each participant in the profits or production of the JV in order to reduce the potential for conflict down the road. For instance, if the JV's activities involve the manufacture of products a participant's specified interest might be a percentage of each product produced.

Consult an Expert

Keep in mind that the foregoing information is a generalization and is intended as an overview. To get information about the specific laws and requirements in your area, you should obtain legal and financial advice from local experts.

Image by Gerd Altmann from Pixabay