What Is A Due Diligence Period Buying Business?
The due diligence period is an opportunity to dig deeper into a company's legal, financial, and operational aspects before you commit to a final purchase.3 min read updated on February 01, 2023
What is a due diligence period? Buying business assets or stock is a big undertaking. The due diligence period is an opportunity to dig deeper into a company's legal, financial, and operational aspects before you commit to a final purchase. This is your chance to confirm the accuracy of the seller's representations, as well as to discover any important information the seller might not have disclosed.
Buying a Business Is Different From Buying Anything Else
While you make many consumer purchases without knowing everything there is to know about what you are buying, a business is different. You do not have the protections that a consumer has. You can't take the business back to a store for an exchange or refund. The burden is on you, the buyer, to find out what could go wrong.
The doctrine of caveat emptor ("let the buyer beware") means that you buy at your own risk. You can reduce the risk of making a high-stakes mistake by doing your due diligence.
What Is Due Diligence?
Before deciding how to approach the due diligence period, it is important to understand what due diligence actually is. Black's Law Dictionary defines this phrase by how courts have defined it, which is with this definition:
"Such a measure of prudence, activity, or assiduity, as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent man under the particular circumstances; not measured by any absolute standard, but depending on the relative facts of the special case."
Not exactly helpful. A better working definition is this: The careful work or effort reasonably expected from and ordinarily exercised by a person who seeks to satisfy a legal requirement or to discharge an obligation.
An Application of Due Diligence
It is easier to evaluate due diligence from the perspective of the future. Imagine that after the sale you find out that the seller sold the assets of the business without disclosing 10,000 outstanding warranties to cover for faulty products. Honoring these warranties will put you out of business. You petition the court to rescind the purchase agreement due to a seller's failure to disclose these obligations.
The court will look at whether a conscientious buyer in your shoes through reasonable efforts could have discovered this problem during the due diligence period. If due diligence would have uncovered this, there won't be anything a court can do to help you.
How Long Is the Due Diligence Period?
A buyer has a fixed period of time following a letter of intent to do due diligence. This letter of intent will specify this period, which is negotiable. A starting point is 60-90 days, depending on the complexity of the business. For good cause and if both parties agree, you may extend it.
The due diligence period should be long enough to allow for the buyer to:
- review voluminous documentation
- physically inspect assets
- hire professional appraisers to value individual assets or the value of the ongoing business, if desired
Allow ample time for the seller to obtain audited financial statements if those statements are not audited already.
What Can Due Diligence Tell Me That I Don't Already Know?
Doing your own Internet research allows you to find out what kind of publicity the business has received, including customer testimonials. It could be valuable to know what kind of reputation or buzz, if any, your future business either enjoys or battles.
You will also want to collect, inspect, or evaluate the following:
- Business registration and current standing in any state in which the seller conducts business
- Audited financial statements for 5 years
- Assets (real estate, personal property, and intellectual property)
- Employee salaries and benefits
- Licenses and permits
- Pending or threatened litigation or environmental issues
- Contracts to which seller is a party
- Product or service lines
- Customer data
- Insurance policies
Using a due diligence checklist is a good way to make sure you don't leave out anything important. You may want to use a checklist that matches your specific business target. If, for example, your business is a real estate venture, you may wish learn more about real estate due diligence in particular.
If you need help exercising your due diligence to buy a business, post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.