Litigation + Valuation Perspectives

Demystifying Valuation, Economic Damages + Forensic Accounting

Due Diligence Tips for Buying a Business – Part II

In following the story about Leonard and Sylvia here are some tips on assets that may save you disappointment after the deal is done.

ASSETS

Cash:
• Cash is generally not included in the sale.  However, cash accounts should be reviewed for large and unusual transactions in the period preceding the deal.

Accounts receivable:
• Obtain and review aged accounts receivable schedule.
• Review status of customers or clients with large balances.
• Determine if receivables have been factored (borrowed against).  This can be done by conducting a UCC filing search.
• Obtain seller representation that all borrowings secured by receivables have been fully disclosed.

Inventories:
• Consider taking a physical inventory to establish existence and condition of inventory.
• Compare inventory values on financial statements to insured values.
• Review insurance loss payable provisions to uncover borrowings against inventory.

Equipment:
• Review repair and maintenance accounts to see if needed work has been postponed to enhance earnings during the presale period.
• If equipment is specialized and expensive, consider engaging a professional appraiser to assess value and condition.
• Obtain seller representation that all liabilities secured by equipment have been fully disclosed.
• Review insurance policies to compare insured values to values represented by seller (or assumed by buyer).
• Review loss payable endorsements to uncover borrowings secured by equipment.

Leased equipment:
• Verify with lessor (preferably in writing) that leases can be assigned to buyer, if that is the intention.
• Verify that financial projections reflect any assumed purchase options at end of lease terms.
• Obtain seller representation that all leases have been fully disclosed and that leased equipment has not been booked as an asset on the balance sheet.
• Review the actual lease agreements.

Real estate assets:
• Consider engaging a professional appraiser to assess value and condition of properties.
• When appropriate, contractually obligate seller to make repairs prior to closing or reduce purchase accordingly.
• Consider engaging environmental engineer to assess potential environmental problems.
• Obtain seller representation that all known actual and potential environmental problems have been fully disclosed.
• Review ownership documents and zoning ordinances for unanticipated restrictions on use of property.
• Review insurance policies and property tax statements to compare insured and assessed values to values represented by seller (or assumed by buyer).
• Obtain abstract of title, reports from title insurance company and public records to verify ownership and search for tax, mechanics and other types of liens against properties.
• Obtain seller representation that all borrowings and liens against properties have been fully disclosed.
• If real estate is subject to favorable mortgages, verify with lenders that these can be assumed by buyer.

Leased real estate:
• Verify with lessor (preferably in writing) that leases are assignable to buyer.
• Investigate renewal terms for leases that will expire in the near future (often, renewal provisions will be significantly less favorable than existing terms).
• Verify with lessor that there are no unpaid lease obligations beyond those disclosed by seller.
• Check zoning standards for unanticipated restrictions on use of the leased premises.
• Obtain seller representation that all leases have been fully disclosed and that leased real estate has not been shown as owned on balance sheet.

Intangible assets (trademarks, franchises, patents, customer lists, workforce in place, etc.):
• Make sure that all material statutory and nonstatutory intangible assets have been identified, and that the proposed transaction includes legal transfers of all intangible assets and rights that buyer intends to acquire.
• For “statutory” intangible assets, review patent documents, copyright registrations, etc. to verify that seller is rightful holder.
• Obtain seller representation that statutory intangible assets in question have not been assigned to third parties or used as security for borrowings.
• Determine remaining number of years of statutory protection for statutory intangible assets.
• For franchises, verify that franchise rights can be assigned to buyer, determine if franchiser will charge a transfer fee and determine remaining term under franchise agreement.

Part three of this post will provide tips on liabilities.

Don Bays, CPA/ABV, CVA, CFF