Due diligence - what does it mean?

What is due diligence? If you have a business background you may know what it means, but many franchises are bought by people who haven’t been in business before – in fact, that’s part of franchising’s appeal.

Google ‘due diligence’ and you will find many different definitions, but a good one to use here is, ‘a comprehensive appraisal of a business undertaken by a prospective buyer, especially to establish its assets and liabilities and evaluate its commercial potential.’

Due diligence is therefore the process that you would expect any sane person to go through before investing thousands – or hundreds of thousands – of dollars in a business opportunity. It will usually involve getting a franchise-experienced accountant and lawyer to check out the business on your behalf to make sure it suits your needs. A lot of people, though, don’t bother.

A survey of over 600 franchisees and independent small business owners in Australia has found that 45 percent of current franchisees had never heard of the term ‘due diligence’ or didn’t know what it meant. For former franchisees, the figure was 54 percent. That’s actually higher than the equivalent rates for independent owners (41 and 35 percent, respectively).

The research, by the Asia Pacific Centre for Franchising Excellence, also found that even among those who did know what due diligence means, time spent on it was found to be ‘relatively low’. And only around a third said they consulted with an accountant, lawyer or financial advisor prior to purchasing or starting a business.

Such carelessness makes business buyers easy prey for deliberate predators, or those selling an under-developed franchise system or an over-priced franchise outlet (yes, outgoing franchisees can be devious, too). But it also means that buyers are simply more likely to make a mistake and choose a business that doesn’t suit them or that they can’t afford.

So if people don’t understand what due diligence means, let’s drop the jargon and call it a pre-purchase inspection. After all, that’s what you’d do if you were buying a house or a car, so why wouldn’t you do it when you buy a business? It’s a bit more complicated, of course, but there are plenty of people who can help. Here are some ways to start your own pre-purchase inspection:

1. Learn about franchising.

2. Find the right franchise.

3. Find a franchise-experienced accountant to help you.

4. Find a franchise-experienced lawyer.

5. Find a banker with specialist franchise knowledge.