Why does due diligence matter in a partner buyout?

A partner who has worked in the business for years can feel diligence is unnecessary. But being inside the business is different from having reviewed its books, and the person leaving may know things about them that you do not. BDC lists what a buyer and accountant should be given, including year-end statements, tax returns, bank statements and aging reports, and advises seeing whether the numbers add up and whether tax returns match the statements. The same test applies when the seller is your partner.

Know what your access rights cover

For a federally incorporated company, section 21(1) of the Canada Business Corporations Act lets shareholders examine, during usual business hours and subject to section 21(1.1), the records described in section 20(1), which are the articles, by-laws, any unanimous shareholder agreement, shareholder minutes and resolutions, and the securities register, among others. Section 20(2) describes accounting records and directors’ minutes separately, and section 20(4) opens them to inspection by the directors. So do not assume shareholder status opens every ledger. Provincial corporate statutes have their own provisions, and a shareholder or partnership agreement may add access, so check what yours says.

Test the structure before the price

Who pays matters. Under section 84(3) of the Income Tax Act, where a Canadian-resident corporation redeems, acquires or cancels its own shares, it is deemed to pay a dividend equal to the amount, if any, by which the amount paid exceeds the paid-up capital, subject to exceptions in section 84. A purchase by the remaining partner personally is a different transaction. Ask your accountant to compare the two on your facts. The cash side is covered in can I use business cash to pay for a partner buyout.

Ask for protection against what you miss

BDC says even after reviewing every document you could still be liable for something the seller did or failed to do before handing over the business, and suggests an indemnity agreement from the seller for unforeseen liability for a period after the sale. In a buyout, ask your lawyer whether the departing partner should give one. BDC’s searches for liens and pending lawsuits, and its check that the business has paid all its taxes, belong on your list as well, because your partner is also a seller.