Due diligence.....

Taking a look at the particular aspects that should form part of any complete due diligence.

By Kobus Oosthuizen

In our previous article we established that due diligence is the process of acquiring information to support a business valuation. It is in the process of confirming the numbers and in doing so the probability of achieving future profitability. While this is central to validating the valuation model, there are further elements to the due diligence process that should not be ignored.

While the income statement illustrates the movement in equity, i.e. how much money has been made and added to the reserves of the business over a certain period, the balance sheet reflects the actual asset and liability position of the business. Statutory audits, however, are seldom performed on information less than three months old and yet it is exactly this information that is of particular interest when conducting a business valuation. It also means that the financial information on which the valuation is based has probably not been audited.

For this reason, in order to ratify the valuation based on the unaudited financials, it is necessary to assess additional factors and ask a few more questions of the owner.

We highlight a few of the additional factors that will require your further attention.

VAT returns

Comparing the information declared on VAT returns and the subsequent payments to SARS is standard procedure in compiling annual financial statements. It is also an effective means of confirming that turnover figures are correct, and that expenses have not been understated.

Performing this exercise as part of your due diligence is probably your most effective way of verifying key financial information.

Tax clearance certificate

Although the process of applying for a tax clearance certificate can be off-putting, purchasers are encouraged to insist on such a document as part of their due diligence process, at least before the last payment is made to the seller. In the instance of larger businesses, this requirement should be non-negotiable.

Verification of key balances

The under-declaration and non-disclosure of direct or latent liabilities within a business, poses a significant risk to the purchaser. Although any good sale and purchase agreement will state that the seller indemnifies the purchaser from any claims against the business arising from circumstances before the date of transfer of the business, prevention is better than cure and key liability balances should be verified prior to the planned date of transfer.

Key liabilities that should be verified include:

Ø  Rental payments

Ø  Royalties or other amounts due to the franchisor

Ø  Monthly loan repayments, as any loans would be settled as part of the transaction

Ø  Utility accounts

Ø  Primary suppliers

If the business in question is operating at a reasonable profit, none of the abovementioned balances should be out of terms, but if they are, an explanation should be provided.

It is recommended that the sale and purchase agreement includes a clause permitting the purchaser to deduct outstanding liabilities and settle creditors directly.

Employment costs and accrued leave

Although the assets of the business may be the "sale object", and the entity within which the seller operated the business may cease to exist, the purchaser’s obligation towards employees is not affected. Besides confirming that staff are currently remunerated in terms of their employment contracts and, if applicable, within the parameters set by the related bargaining council, the value attached to accrued leave should be calculated. During negotiations the purchaser should also take into account the fact that accrued leave is a real liability, which the purchaser will inherit.

In the following article we investigate how an existing lease and franchise agreement may impact the sale of a business.□

Kobus Oosthuizen
SA Franchise Warehouse
www.safw.co.za