Due Diligence Review for Purchasing a Business - Part 3

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!