What is Due Diligence?
Due diligence is seen as the activity when one conducts a comprehensive investigation or audit of a potential investment, such as the purchase of an online business. Due diligence refers to the research done before entering into an agreement or finalizing a financial transaction with another party.
In the context of digital business acquisition, it’s an audit performed by the prospective buyer of a website or an online business, as well as the seller of the respective investment. Also, the seller can perform due diligence to identify whether the buyer has enough resources to complete such a purchase. On the other hand, potential buyers can also conduct due diligence through searching this company before they decide to finalize a sale. This sale can be for the business as a whole or shares for part-ownership.
The due diligence is needed to ensure all information about the site is correct and it is required to prove that the website is indeed as expected.
Why is Due Diligence Crucial When Purchasing an Online Business?
As pointed out, the necessary research needs to be done to make sure it's a smart investment. Just like any traditional businesses, same applies when dealing with online businesses.
Online assets are likely to be counterfeit, and it is easy to manipulate opinions by not reflecting the truth in this area, due care must be given when dealing with an unfamiliar business like websites.
Fortunately, there are plenty of ways to measure the legitimacy and accuracy of the representations and warranties of an online business. With the help of digital footprints, underlying manipulations and counterfeit data are easy to uncover. All that needs to be done is to focus on the correct data and ask the relevant questions in the due diligence process.
The Essential Due Diligence Checklist
Here are some important factors that should be considered when conducting due diligence to an online business or website in the purchasing an online business or website:
1. Organization and Ownership of the Online Business
Generally speaking, when purchasing an online businesses, it’s technically not required to meet in person with the owner of the online business before going forward with the definitive purchase agreement. It is, however, important to bear in mind that their identity at least must be verifiable. As a bare minimum requirement, the business owner should be accessible on social media platforms. This step is highly crucial as it reduces the possibility of investing time and helps avoiding the potential frauds. Besides, if something goes wrong, this will provide buyer with some level of accountability.
We highly recommend that the checklist includes what the owner's responsibilities are in the business, how long does it take to perform their duties, and whether technical experience is required in the relevant field. Most efficient way to assess the time and responsibilities required to keep the business running is to conduct a ‘task audit’ for the owner and the employees of the business. Ensuring that the seller has a company, history, a decent reputation and a legitimate audit trail may be a key starting step.
2. Financial Information
The financial information of an online business is one of the most important pieces of data that can be collected in the due diligence stage. It is important to have access to the previous and current financial records of the business before proceeding with any purchase.
If possible, previously provided financial information made available to buyer should be checked by the financial advisor of the buyer. It is helpful to keep track of all loans, debts and obligations associated with the business before signing the contract. Even slight fluctuations in the P&L charts of the business can give up many details as to how the business is really doing.
It is suggested to ask questions about whether the payment accounts of the business is transferrable and, if the answer is negative, what are the procedures for opening a new account. For example, since it is not possible to transfer accounts in online payment systems such as PayPal, an easy and straightforward way to open a new account with these questions should be determined in advance. Because when acquiring a business, it is critical that you are fully aware of the historical and current financial position of the business. In order to do so, it should be checked that the business has maintained an accurate and detailed financial record from the beginning.
3. Taxes
It is necessary to ensure that the online business that you are interested is tax compliant.
Checking whether the taxes paid meet the required amount in line with the income of the business is crucial to ensure a smooth transaction and realizing the real potential of the business in future.
First of all, it is necessary to find out in which countries the online company to be purchased sells, and then in which countries there is a VAT registration. In this regard, it would be reasonable to dig a little further in as to whether the online business to be purchased is VAT compliant in the European Union or whether there are any VAT registration in any country in the Europe. This issue needs extra attention, because the lack of VAT compliance is seen as a red flag in many online marketplaces.
4. Staff/Employee or Contractors Information
It is necessary to have information about the employee structure of the company to be purchased and the use of contractors. It would be useful to know exactly what happens behind the digital façade of the company.
It is also important to clarify issues such as whether the employees/staff will accept to work under the same conditions, whether they have information about the sale of online business. A "key man risk" is about how reliant the business is on its employees. In regard to this risk, buyers should carefully examine the role that the employee plays in the business and discern what kind of proprietary knowledge is required to maintain those responsibilities.
5. Legal Verification
Besides issues with direct transactions, some of the biggest problems when it comes to online businesses are trademark infringements. Trademark infringement is the unauthorized use of a trademark or service mark on or in connection with goods and/or services in a manner that is likely to cause confusion, deception, or mistake about the source of the goods and/or services. Due to this, it is use to make sure that business is being operated lawfully. This helps mitigate the risk of illegal trading and intellectual property violations.
Legal due diligence is also necessary to ensure the sustainable growth of the business. Due care needs to be given to analyze how the previous owner of the business legally managed the company and how his decisions affected the business to that end.
As the deal size increases, more legal due diligence will be required, contracts being a pertinent example. But it is possible to avoid legal problems in future online business by performing rigorous legal verification in advance.
6. Intellectual Property
When purchasing an online business, it’s important to assess their intellectual property status as well.
One of the first things to do when it comes to intellectual property is to confirm the business owner's rights over the IP rights of the business. After confirming that their claims are valid, it must be ensured that the contract includes active and direct reinforcements against third-party companies.
Questions about whether there are any registered trademarks in the website name or domain that third parties (as far as is known) can claim rights, whether the trademark is registered with the USPTO or trademark offices in another country, or whether there is a trademark in a similar niche should be directed.
7. Website Traffic
One way to measure the success of an online platform is to see a traffic report of visits, clicks, and conversions from an online business. The more traffic the online business attracts, the more potential customers and consumers will be encouraged to purchase the products offered.
When conducting due diligence on website traffic information, the following should be checked:
· Average time on page
· Number of pages visited by visitors
· Traffic and conversions
· Analysis of where online traffic is coming from
In this regard, it is important to learn the average time spent on the website and to get information about whether there is an equal distribution of traffic across the pages.
8. Operational Process
Before buying the business, it should be understood how the business will be run without the help of the original owners or vendors of this digital company. The new potential owner must understand the operational process of the online business, from the number of responsibilities to the smallest tasks.
Whether the company has standard operating procedures (SOPs), and if so, which standard operating procedures are questions to be addressed at this point. This may give you a clue on how dependent the business is to its former owner.
9. Products and Services Provided
As an online business, probably one of the key aspects of the company is to determine what are the products and services that are offered. At the end of the day, people will only visit the website if they really see a potential in it.
If the business’ revenue generation model is mostly product-oriented, special care needs to be given to supply chain, management of returns and shipping.
10. Client/Customer Information
Another important due diligence element to consider is to memory of customer information. Before acquiring a digital business, existing customer data from previous management should be thoroughly researched and analyzed, to the extend permitted by the applicable data privacy laws. This pile of data gives the buyer an idea as to how the customers will react to potential changes based on their past patterns of behavior.
Conclusion
These are just a few of the key considerations to regard when it comes to purchasing an online business. In a nutshell, it is highly crucial to consider unique sides to purchasing an online business in order to ensure you have a smooth and hassle-free takeover of the business.
From the very start of the negotiations and due diligence to preparations of the definitive asset or share purchase agreements, it is highly recommended that you have a team of legal and financial advisors specialized on online business purchases by your side
AUTHORS
Attn. Ferhan Yıldızlı
Selenay KÖSE, Legal Trainee