The future of the economy looks to be a brighter place for UK businesses as confidence has returned to pre-recession levels, say BDO Stoy Hayward in its latest report. The accountancy firm’s Optimism Index rose from 99.4 to 103.2 in March; a high not achieved since the summer of 2006. The Output Index also improved, and has reached quarter three 2007 levels due to businesses re-stocking.

This renewed optimism is reliant on the three main political parties outlining their economic policies for the future, however, according to BDO.

The accountancy firm said: “The lack of information from political parties regarding concrete plans to tackle the deficit will be contributing to business uncertainty which in turn is keeping investment levels low in 2010.”

In other encouraging news, activity in the construction sector of the economy picked up last month according to the British Chamber of Commerce. The CIPS Markit PMI construction index rose from 48.5 to 53.1 in March the first time in two years. However, construction businesses might be vulnerable to reduced government spending on building and infrastructure projects. Read our guide on how to buy a construction business by subscribing to the Business Sale Report.

The importance of due diligence to the success of a transaction is often underestimated. We thought it might be useful to put together a few pointers to keep in mind while running a due diligence exercise on a business you are intending to buy. A more thorough explanation of what is required is available to subscribers.

Approach the whole process with a very objective and critical eye. When you have seen a business to buy it is very easy to get carried away and marvel at your own cleverness at seeing such a good opportunity. But always remember that it is much easier to evaluate what has been presented in a memorandum of sale than to spot what has been left out.

Get the right advisors

Buying a business is a team effort and the most important members of your team are your accountant and your solicitor. Make sure that you have a good working relationship with both and they are properly instructed. If you need to appoint new advisors do so on recommendations to ensure they have the appropriate skills.

Plan it, scope it

Define the scope of the due diligence exercise and clearly mark out who is doing what and when. Work to a timeline. In order to conduct a thorough investigation you must have everything in order before the due diligence process begins. In fact, you must start your due diligence preparation and information gathering the moment you decide that you are interested in a particular business. You will need the following:

An exact step-by-step plan of the entire due diligence exercise.
All of the information and relevant items you need from the seller before you start the analysis.
A checklist of… (more available to subscribers)

Employee issues

Thorough due diligence should pick up any issues, risks and potential liabilities relating to the seller’s employees. For instance, check if there are any past or present employees litigating against the business. Other important areas to look at might be the following.
Do any of the employment contracts have unusual clauses i.e. over-the-top redundancy packages?
What are the specifics of the pension plans?
What is the bonus structure and is it rewarding performance fairly?
(more available to subscribers)

Move fast, top down

It is important to spot any issues early on so that the appropriate warranties and indemnities can be quickly put in place. As these are legal documents, which are meant to protect both the buyer and seller from things going wrong, they can be complex, expensive and take time to put together. Focus on major issues first.

Communication is vital

The flow of communication between the buyer and his/her solicitors is of paramount importance, for if they do not work closely together, the process can quite simply fail. The buyers must communicate the key issues of concern to their solicitors; they should not just assume that all areas are of equal importance, and that everything will be dealt with in good time. Continually monitor the activity of the solicitors and accountants carrying out your diligence and make sure they are giving you regular feedback.

Don’t forget the culture

Funny how the lack of understanding of the target’s company culture is one of the main reasons for failed acquisitions, yet this has been notoriously ignored in the due diligence process. Don’t make the same mistake. This is usually one for the purchaser’s management to consider, rather than delegating to legal or financial advisers. Map out the management styles of your business and the target business. In the report we look more closely at the culture of a business.

Collect information, then analyse

Don’t let any of your advisers analyse whilst collecting the information. These are two distinct activities within the due diligence process. First find out where the required information is, then collect the information, recording its source and noting whether it is fact or hearsay. Then start an objective analysis.
Finally, make sure you differentiate between fact and opinion. Information that is presented as fact should be signed off by the target company’s directors.

Don’t panic, take your time

A focused but comprehensive approach is better than taking shortcuts in order to reduce costs. Often the buyer discovers that ‘thin areas’ of diligence need to be covered again in more detail, ultimately consuming extra time and costs.

In partnership with the Business Sale Report Smithfield Partners Solicitors and WM ProServ LLP, accountants are offering £5000 worth of free legal or accounting Due Diligence. What is the catch? This offer is only available to the first 5 companies that apply via the Business Sale Report. To qualify you just fill in our due diligence enquiry page.

We wish you luck in finding a great investment for 2010!

Buying a business is not like buying a car. Get it wrong with a business and it is likely to seriously hurt your wallet. So how can you tell if you are looking at one where the wheels might fall off? Nick Pritchard from Transaxman ltd has helped us put together a few examples of what to look out for and how to assess the true profitability of a businesses. Remember that the seller knows a lot more about the business than the buyer.

There are a number of indications that a business is in difficulties. Such as reduced recruitment and training activity, delay of planned maintenance, missing a major trade show, closure of product or quality development teams and reduced investment in tooling or software. When companies are prepared for sale, if the business is in some difficulty, they may simply cease any forward expenditure or investment. Continued investment in a business is essential in ensuring growing profits. This is often the reason that the best businesses to buy are the ones that are not actually being marketed for sale.

So you have seen a great business and you are doing due diligence. Don’t let the vendor pull the wool over your eyes! There was one well documented fraud where everything seemed hunky dory, but the vendors had hired in a number of temporary staff to make the factory look busier while the potential buyers were looking around.

Arriving at the adjusted net profit

There are essentially two main types of adjustments that need to be made:

* Allowances for non-recurring items, such as a grant or a big debt
* Items shown as costs that are really a distribution to the current owners.

For example, distributions to owners might be special pension contributions, or expenses that are a consequence of the life style of the shareholders, as well as the usual salaries and benefits in kind. In one instance a US business was in the process of buying a company in South Wales, unfortunately the vendor had forgotten that he had put his Cardiff Arms Park debenture through the company – Once the purchaser understood the importance of being able to take customers to the match, the vendor had to buy his own tickets.

Where a company occupies its own freehold property it may also be necessary to adjust the trading results for a notional rent charge, if the property is worth substantially more than its book value.

Standardising earnings
The purpose of restating results is to show what the earnings of the business would have been on a standardised basis, as a guide to the future earnings. The valuation exercise is done therefore to establish how much a theoretical buyer would be prepared to pay as a capital sum in exchange for the right to receive those future earnings.

Earnings for this purpose would be trading profits before interest but after a notional taxation charge. This recognises that the value of the business may be different from the value of the equity, as the latter value will depend on how the business has been financed. Where businesses have accumulated cash reserves it should be remembered that these funds represent past earnings which have not been distributed.