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Doing Your Due Diligence When Buying a San Diego Business

When contemplating buying a San Diego business, as the buyer, you must always engage in what is called “due diligence” before finalizing the purchase. Basically, due diligence is research that you do after you sign the Sales Agreement. To a degree, a form of due diligence is conducted when you buy a house. You sign a Sales Agreement on the first of the month, but you do not expect to close for 30 or 60 days. During that time, the mortgage company, the brokers, and the lawyers are reviewing and processing approvals, checking pay stubs and financial documents, and making sure all parts of the house purchase are in order. This is a mild form of “due diligence.”

It goes without saying that the due diligence needed for buying a San Diego business is much more complex and intense. You are going to need an experienced San Diego business lawyer to guide you.

Buying a San Diego Business: Importance of Due Diligence

A well-drafted Sales Contract will also have a “due diligence” period ranging from a few weeks to a few months, depending on the complexity of the purchase. This allows the buyer and his or her lawyers to do the research and make sure that all aspects of the deal are in order and are acceptable and “as agreed.”

Likewise, a well-drafted Sales Contract will have various “outs” for the parties if the due diligence uncovers various issues that are unacceptable. Both sides may have “outs,” but mostly, they will be for the protection of the buyer. For example, if the key for the buyer is keeping the retail location for the business, then the Sales Contract will provide that the deal will be “null and void” if the landlord will not allow assignment of the lease — assuming approval is needed. Thus, some problems will cause the deal to “die.”

On the other hand, if the due diligence has uncovered a large “problem” or several “problems” that can be fixed, then the parties often attempt to renegotiate the deal. Obviously, the deal will “die” if the parties cannot agree — often a price reduction is the fix — but more often than not, a new deal can be achieved. Finally, if the due diligence shows everything to be “all good,” then the deal will close.

Buying a San Diego Business: Main Components of Due Diligence

There are four main components of due diligence:

Reviewing the documentation
Reviewing laws and legal issues
Checking the equipment, inventory, and tangibles
Obtaining the approvals and waivers

Buying a San Diego Business: Reviewing the Documents

Here is quick, non-exhaustive list of documents that you will want to look at before the closing:

Leases for any store, factory, office locations
Title abstracts for any real estate owned that is part of the deal
Environmental documentation (if applicable)
Contracts of every sort that are being assigned — employment, vendor, sales, nondisclosure, licenses, etc.
Yearly sales reports, monthly cash flow, and similar
Accounts payable and receivables
Expense reports, utility statements, lease/real estate-related expenses, labor costs, capital expenditures, equipment and material costs, etc.
Government filings (as applicable) — department of labor, franchise tax board, city permits and approvals, etc.
Regulatory compliance (as applicable)
Customer/client lists
Employee documentation (if applicable) — training manuals, employee handbooks, benefit plans, company policies
Tax returns, financial statements, and other financial documents particularly related to debt
Corporate books (if applicable) including minutes of meetings, copies of articles, operating agreements, shareholder agreements, etc.
Franchise, dealer or other type agreements (if applicable), renewals, and disclosures

Because every business is unique and every industry is unique, this is only a partial list. Obviously, buying a restaurant franchise is different than buying a free-standing single restaurant, which is different than buying a consulting business. The documentation that must be reviewed varies with the type of deal and the size of the purchase.

Buying a San Diego Business: Reviewing Legal Issues

It is also crucial to review legal issues and regulations prior to a sale as part of the due diligence. Just because the seller is operating the business in a certain location does not necessarily mean the seller is complying with various laws, such as zoning, use, etc. Maybe the city has just not noticed. As the business changes hands, the business now comes to the attention of the regulators and, now, there is a problem. This can be a particular problem with long-established and long-running businesses. As an example, over a 20-year time span, many new laws and regulations are passed. Often those are “grandfathered” with existing businesses or just sort of ignored by city employees. But, again, with a change of ownership, the business, its location, etc., comes to the attention of the regulators. New lenders may also bring a new focus to legal issues such as building and fire codes, security, and the like.

Another aspect of the due diligence regarding legal issues concerns the corporate forms and whether the deal might be better as an equity purchase or as an asset sale. A well-drafted Sales Agreement will allow for this flexibility. See our discussion regarding the Walgreens and Rite Aid merger/asset sale here.

Buying a San Diego Business: Checking the Equipment

If equipment or inventory or other tangibles are a significant part of the deal, then such will need to be checked and verified. Equipment should be checked for repair and maintenance status; inventory for quality, saleability, and freshness (if applicable), etc. These are often the most “fixable” issues if due diligence uncovers problems.

Buying a San Diego Business: Obtaining the Approvals/Waivers

Again, depending on the deal, there may be approvals and waivers needed from third parties. Approvals might be needed from lenders, title companies, landlords, suppliers, and the like. Waivers might be needed for tax-related issues, from lenders for financing collateralizations (e.g., UCC), from unions with respect to dues/contributions and the like. In this category is also the need for any agreements with key employees that might be retained by the new owners.

Buying a San Diego Business: Contact San Diego Corporate Law

For more information, contact experienced business attorney Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard has many years of experience handling all aspects of the sale or purchase of businesses in San Diego and elsewhere in California. Mr. Leonard can provide advice and guidance on all aspects of the due diligence process and can advise on issues of asset sale/purchase as opposed to a stock sale/purchase. Contact Mr. Leonard by email or by calling (858) 483-9200.