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What constitutes due diligence when buying a business? Part 1

When you buy an existing business, you probably know that "due diligence" is your responsibility. That basically means finding out all the relevant information about the business -- everything you would need to know to run the company and to live up to its current obligations, which you will be assuming.

A small business attorney can be an asset in the due diligence process because they have experience performing this crucial obligation. To get you started, however, we will be covering the basics of due diligence over our next two posts. This is not meant as an exhaustive list of everything you should consider during due diligence, but it can give you an idea of what questions to ask and the level of detail required.

Is the organization set up correctly and operating in good standing? For example, if it is a corporation, are its articles of incorporation and bylaws in order? Are its meeting minutes up to date? How is stock accounted for? Similar questions apply to partnerships, limited liability companies and other entities. Also, obtain a list of all states in which the company operates and annual reports for the last three years.

How is the company performing financially? Check its audited financial statements and auditor's reports, along with the most recent unaudited statements and the company's credit report. You will need a detailed understanding of the company's projected income, debts and contingent liabilities, so check the company's general ledger, accounts payable and receivable, capital budgets, fixed and variable expenses and inventory schedule. You will need any budget projections, analysts' reports, strategic plans and internal control procedures.

What real estate is included in the sale? Get a list of all the company's business locations. Ask for copies of all leases, deeds and titles, along with mortgages, easements, zoning approvals, use permits and title insurance.

Are there environmental issues? Does the company own any brownfield real estate? If so, be sure to get a legal opinion on your potential liability. Have environmental audits been performed? Has there been any contact by the EPA or state regulators? Also, does the company work with hazardous substances or create regulated pollution? Does it have up-to-date licenses and permits?

What are the company's physical assets? This includes all fixed assets and their locations, equipment leases and a schedule of any sales or purchases of capital equipment in the past three years.

What intellectual property does it have? Check a schedule of domestic and foreign patents, along with patent clearance documents, licenses, trademarks, trade names, copyrights, proprietary processes, methods to protect trade secrets, "work for hire" agreements, consulting agreements and nondisclosure agreements.

We'll continue this list in our next post.

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