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Due Diligence When Buying a Business

Regardless of whether you are a serial business owner or you are looking at becoming a business owner for the first time, engaging in due diligence will be a key factor in whether or not the business succeeds. That’s because the success of a current business is often dependent, as a starting point, on the information you received prior to actually purchasing the business.

Due diligence requires, at a minimum that you review several years’ worth of tax returns, profit and loss statements, balance sheets, and current leases and contracts, including employment contracts, insurance policies, review federal and state taxes, UCC liens and judgment searches, assess any potential claims or lawsuits against the business, review corporate minutes, and check that the business’ registration with the Minnesota Secretary of State is active. However, the type of information that you need to review is also dependent on the type of business that you are purchasing.

Here are a couple of specific examples (this is not an exclusive list). First, if you are purchasing any type of commercial or industrial real property (such as with a convenience store), you will want, at a minimum, a Phase I environmental site assessment. This assessment will inform you as to whether or not the site is contaminated. If you waive the Phase I, which is not advised and later it turns out that your property is contaminated, you are responsible for cleaning up the contamination. Second is if you are purchasing a business that requires a certain type of license. At a minimum, you will want to make certain that the business holds the proper licenses, and is not on any probationary or other disciplinary status. Third, if the business you are purchasing is a franchise, the franchisor’s approval is required. It is important to know immediately the requirements of the franchisor in transferring a franchise from one business owner to another. Depending on the franchisor, you may not qualify to buy the business. Therefore, it is important to know the franchisor’s requirements upfront before investing thousands of dollars on due diligence and starting a new legal entity.

You also need to make certain that the person(s) who is selling you the business actually owns the business. It is not uncommon for business owners not to understand the technical aspects of ownership. For example, you believe that the business is a sole proprietorship, but actually it is an LLC. The LLC has the authority to sell the business, not the individual owner(s).

Being a business owner is a rewarding experience. However, you do not want your hard work to be in vain because you decided to forego spending the necessary legal fees upfront on conducting due diligence. You are better off walking away from a business deal after knowing all of the facts, then buying a business with the facts being unknown.