Due diligence audits may sound technical and tedious – and in fact they kind of are – but they are also a critical part of purchasing a business. A thorough due diligence audit goes well beyond simply reviewing the financial statements to help you to gain a deep understanding of the various facets of the business that you are looking to purchase. You may well discover a few surprises that you may have never been made aware of otherwise – and they might be good surprises or not so good ones.
Having as much information about the business upfront can help you to better assess the risks and benefits related to the acquisition and make a well-informed decision about how best to proceed.
Why do I Need to Do a Due Diligence Audit?
When you find yourself in a position of potentially purchasing a business, it can be all too easy to get caught up in the excitement of the opportunity. Often, the foremost thought is focused on how profitable the business is and/or how much money can I make? While profit potential is certainly an important consideration as part of the decision making process, it is far from the only thing you should be looking at.
There are many other things that are important to understand in order to get an accurate indication of the true current business position. A due diligence audit can also help to identify indicators and factors likely to affect the future performance of the business, as well as to uncover any “skeletons in the closet” that may not have been expressly communicated by the vendor. While no one likes to discover “skeletons” that pose potential risks and challenges to their dream purchase, it is much more preferable to be made aware of these matters as early as possible in the process, rather than to have those skeletons jump out to surprise you later down the track, when it’s all too late.
You can find out more about some of the legal considerations associated with undertaking a due diligence audit and other Important Things to Consider when Buying a Business in our recent article.
Who Should I Engage to Conduct my Due Diligence Audit?
The outcome of a due diligence audit will likely have heavy influence on a very important (and usually very expensive) decision.
For this reason it is extremely important to engage the services of experienced due diligence auditors, like the team at The Quinn Group, to carry out your due diligence audit prior to purchasing a business. While there is a cost involved in carrying out a comprehensive due diligence audit, it is a worthwhile cost in order to have the most accurate and thorough review.
Attempting to DIY, or compromise on knowledge and expertise, when it comes to undertaking a due diligence audit can have potentially devastating consequences. So it is critically important to invest the time and money to ensure a rigorously executed audit process.
What Does a Thorough Due Diligence Audit Look at?
As mentioned earlier, a rigorous due diligence audit will cover not only a financial analysis, but also a review of taxation, legal and operational considerations too.
When reviewing the financials of the business, of course there will be careful analysis of the financial statements such as Profit & Loss (P&L), Balance Sheet and Cash Flow. But it doesn’t stop there. Depending on the individual circumstances of the business that is being audited, the auditors may also likely look at other financial related considerations such as:
Retained Earnings – are they to be paid out in full prior to settlement? Is there sufficient franking credits to pay fully franked dividends? Any hidden tax costs of taking over retained earnings?
Employee Liabilities & Entitlements – are wages, superannuation, PAYG and payroll tax paid correctly, on time and properly recorded? Are employee entitlements and liabilities accurately calculated and reported? Is the vendor entitled to a payout? Does the business use contractors and are they engaged and paid appropriately?
Company Losses – will the new owner be able to access any company losses? Has the business changed materially since losses were incurred? What is the tax benefit of these losses?
Loans: Owner/Director & Third Party – are there any Division 7A loans? How will any money owed to the director or owner be dealt with? Any signed loan agreements and/or personal guarantees in place? If there are any loans with financial institutions, are they aware of the potential sale and are the loan/same credit terms able to be transferred?
Assets – are there any personal assets in the entity eg. motor vehicles? How will these be dealt with and are there any associated tax costs to the buyer?
Tax and Duties
Taxation compliance and other duties comprises a large part of doing business in Australia. It is important to understand the current position of the business in regards to taxation obligations by looking carefully at the following as part of the due diligence audit.
ATO – all obligations lodged and paid in full? Consider the current year provision for income tax, GST, PAYG Withholding as well as income tax and GST compliance and groups for tax sharing and funding arrangements. Do BAS & ITR records match back to financial statements?
Other Revenue Compliance – what other duty obligations does the business have? Customs duty? Land tax? Has stamp duty been considered in regards to financing for the purchase?
Superannuation & Payroll Tax – is the business up to date with its employment related payment obligations, such as superannuation contributions and payroll tax?
Legal Considerations & Operational Risks
In addition to the financial and taxation affairs of a business, the legal and operational aspects are equally important to consider as part of a due diligence audit.
Industry – legal and operational matters can vary considerably depending on the type of industry that the business is operating in and so should be considered and evaluated accordingly.
Legal Action – has the business previously been, or currently involved in any legal action?
WH&S (Work Health & Safety) – does the business currently meet WH&S compliance?
Structure of the Sale/Purchase Transaction – is the sale/purchase intended as a sale of shares or units in the trust, or a sale of business assets? What are the resulting outcomes and considerations for each?
Customer & Supplier Contracts – review the conditions of existing contracts with customers and suppliers. Consider general contract details such as whether they are duly executed, what is the term, any extensions and variations, conditions regarding pricing and price reviews, as well as onerous clauses such as indemnities and warranties, liquidated damages, termination costs and consequences of termination.
Information Technology (IT) & Cyber Security – what is the status of any existing IT licences and infrastructure including data storage and cyber security? Is there provision for continuity and enforceability after transfer of ownership? What are the new owners rights to any custom or proprietary software? Is the current structure compliant with privacy laws and any other necessary compliance requirements?
Intellectual (IP) Ownership – use searches to identify any registered and unregistered IP ownership. Is there anything in place with employees and contractors regarding IP protection? What is the business’ policy, and are there issues, relating to websites and social media accounts?
Property – does the business have restrictions or considerations in regards to permitted uses and environmental issues? Is the property leased or owned by the business? What are the terms and conditions of the lease and/or how will the lease/property be transferred?
Environmental, Sustainability & Governance (ESG) – a review of the business’ practices and policies in regards to environmental, sustainability and governance matters should also be undertaken as part of a comprehensive due diligence review.
Due Diligence Audits are Essential Before Buying a Business
As you can see, there is a broad range of areas to be reviewed when considering buying a business. A due diligence audit will help you to get an accurate picture of the current business position so that you can make a well-informed decision about how to proceed.
This list is by no means exhaustive, but rather serves to give you an understanding of the potential scope of a thorough due diligence audit.
If you are considering buying a business, it is critical that you seek the advice of a professional due diligence auditor. Our experienced team of lawyers, accountants and auditors are able to address your due diligence audit queries as well as conducting and preparing thorough due diligence audit reports. Submit an online enquiry or call us on + 61 2 9223 9166 to arrange an appointment to discuss your individual due diligence auditing requirements.