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Due Diligence Prior to Purchase

Due Diligence Prior to Purchase

The Importance of Due Diligence Prior to Business Purchase

Helping My Client to Assess a Possible Franchise Opportunity …With Negative Financials Identified

In April 2023 my client was considering purchasing a large franchise business that was trading in the hospitality market. My client was an employee of the business and was offered the opportunity to purchase the business from the current owner.

The client took the prudent step of asking us to review all aspects of the business financials, prior to determining whether to proceed or not. He wanted our expertise to assess the strength of this opportunity, the financial status of the business for sale, and any financial implications.

What We Did

As part of providing prudent business advice, we undertook a preliminary due diligence on the local franchise business. This included:

  • A review of company profit figures, for the recently completed financial year, and the 2 years prior.
  • Full review of the company balance sheet, to determine the actual status and accuracy of the provided figures.
  • We identified any cash flow concerns and reviewed the quality of the provided figures.
  • Reviewed all company related tax arrears, including GST returns and income tax returns. This included looking at tax owing/tax debt, whether all income tax returns and GST returns had been submitted to Inland Revenue, and outstanding amounts due.
  • We undertook a standard “Solvency Test”, to determine whether all debts and liabilities could be funded and covered as a result of the business trading in the normal course of business.
  • Completed a review of other outstanding debts, creditors, payments due to staff including holiday pay and entitlements, and payments due to ACC.
  • Our due diligence also took into consideration franchise fees and royalty fees; plus
  • Upcoming and pressing requirements for the business to trade going forward, including a necessary shop refurbishment (estimate prices had been provided), and the replacement of other key of assets necessary for trading.

Our Review Identified 6 Key Areas of Concern

On completion of the review of the business, we identified six key areas of concern, resulting in our advice to the client to not proceed at this point in time, with the business financials currently looking as presented.

Key advice and findings included:

  • The company balance sheet and financial documents were not in a tidy order raising concerns about the accuracy of the data provided, credibility of the financial figures, and the financial health of the business.
  • The business valuation stated by the vendor did not marry up in anyway with the financials compiled as part of our due diligence. It was approximately 4x overvalued by the vendor compared to our assessment.
  • The company and the vendor had significant tax arrears owing, giving further concern regarding the profitability and financial management of the business.
  • When assessing the business opportunity under our “Solvency Test”, we identified that the company was not financially performing at the level required to pay its debts as they became due, and that the company’s liabilities were greater than its assets.
  • The company was significantly behind with its creditors including ACC and several aged creditors.
  • The business, due to its current financial status, was not in a position to fund the necessary shop refurbishment or replacement of key assets, which are very much required.

The Outcome

As a result of completing a preliminary due diligence for our client, we were able to highlight these key areas of concern and explain to him the implications if he were to proceed with the purchase. Our advice to him was to hold off with considering the purchase of this business for at least the next 6-months, while the vendor considers these key findings. This may result in the business undertaking a financial tidy up, or a revisit by the vendor on their enthusiastic business valuation figure.

Advisory Accountants have the experience and expertise to assist you to assess any business opportunity you may be considering. By undertaking some preliminary due diligence we can provide the necessary level of information to help you make an informed decision, regarding the strength of the business opportunity, a realistic purchase price, and any likely trading/financial concerns.

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Advisory Accountants provides business accounting and tax advisory services. Wellington, Porirua and NZ wide.

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