When purchasing a business, the process known as “due diligence” allows the buyer to mitigate risks by thoroughly investigating the business and its principals before completing the purchase. Many purchase contracts provide for a due diligence period, also known as a feasibility period, which gives the buyer time to conduct an investigation.
Key Aspects of Due Diligence When Purchasing a Business
The due diligence process will depend on the circumstances of a particular business transaction. Usually, a business attorney, accountant, or other experienced consultant will help you to determine the best approach for your purchase. However, there are some components of the due diligence that every purchaser should be aware of.
First, buyers should verify that the business is in good standing and exists in the state in which it was formed. For Arizona corporations, a search at the Arizona Corporation Commission can determine whether the entity is in good standing. The buyer can also require the seller to produce a Certificate of Good Standing from the Corporation Commission.
Your business attorney will also need to verify that the person signing the legal documents has the company’s authority to do so. The seller will need to provide you with the business’s governing documents, such as a Shareholder Agreement, Operating Agreement, and corporate resolutions by the Board of Directors or managers authorizing the person to sell the business.
Next, you will need to check for any judgment or liens against the business and its property. This will involve a search of the County Recorder, County Superior Court, and a “UCC” search (for uniform commercial code financing records at the Secretary of State).
Your business attorney will also need to review all critical agreements, such as employment contracts, real estate leases, equipment leases, and insurance contracts.
You, an appraiser, mechanic, or other experienced person should confirm the condition of all equipment and assets being purchased.
It is usually prudent to have an accountant review the accounting records and financial statements.
There will be several additional steps in the due diligence process, depending the circumstances of your specific business purchase.
If any real estate is being purchased as part of the business purchase, you will need to conduct a due diligence specific to each piece of real property. You will need to order a title report on each lot or parcel.
Due Diligence Contract Terms
What if a problem is discovered during due diligence? The purchase contract should spell out what remedies the buyer has, so it is important that you include “contingencies” in the original agreement that give you options. The buyer should negotiate the right to cancel the purchase if dissatisfied with the investigation, and particularly if major problems are discovered. Without specific language that allows the buyer to cancel the agreement, the buyer may be legally bound to close.
The purchase agreement should clearly state the length of the due diligence period, the conditions allowing the buyer’s right to terminate, how the buyer can terminate the contract, and what remedies the buyer has if the seller decides to back out of the agreement after the buyer has expended considerable funds during the due diligence process.
Chernoff Law handles business litigation matters, including disagreements arising out of the purchase or sale of a business in Arizona. Contact us to discuss your case with an experienced business attorney.