No one likes buyer’s remorse, especially if you’re making a big purchase like buying a business.
You’ve found the perfect business to buy. The seller is motivated and willing to negotiate on price. You’re ready to take the plunge and become a business owner.
But hang on a minute…before you sign on the dotted line, you need to make sure you carry out due diligence.
Due diligence is the process of investigating a potential business purchase to ensure that all the information presented by the seller is accurate and that there are no hidden surprises.
It’s important to remember that, as the buyer, you are taking on all the risks associated with the business – so it pays to do your homework!
What Should Be Included in Due Diligence?
As a minimum, your due diligence should include:
- A review of all financial information for the past 3 years, including tax returns, profit and loss statements, balance sheets, etc.
- An analysis of the current market conditions for the industry in which the business operates.
- A review of all contracts and agreements that the business has in place, including leases, supplier contracts, employee contracts, etc.
- An assessment of any environmental liabilities associated with the property on which the business operates.
- A review of all insurance policies held by the business.
- A meeting with key employees to get their feedback on the business operation and their thoughts on working for a new owner.
- A discussion with the current owner to get their views on why they are selling and what their plans are for after the sale.
Why Does Due Diligence Matter?
Carrying out due diligence gives you peace of mind that you know exactly what you’re getting yourself into when you buy a business. It also allows you to negotiate from a position of strength, as you can use any negative findings to negotiate a lower purchase price. Finally, if any red flags do come up during due diligence, it gives you an opportunity to walk away from the deal before it’s too late.
Hard VS Soft Due Diligence
There are two types of due diligence: hard and soft. Hard due diligence looks at the hard facts and figures of a business.
This includes things like financial records, legal documents, and contracts.
Soft due diligence is more about understanding the people involved in the business, and getting a feel for the culture of the company. This can be done through things like talking to employees, customers, and suppliers.
Free Advice
Hard Due Diligence
One of the most important aspects of due diligence when buying a business is reviewing the financials. This includes reviewing the company’s income statement, balance sheet, and cash flow statement.
This will give you a good idea of the company’s financial health and will help you to identify any red flags.
Conducting Background Checks
Another important part of due diligence is conducting background checks on the company and its management team.
This includes checking their credit history, criminal record, and any bankruptcies or lawsuits that have been filed against them. This will help you to get a better idea of the company’s history and will help you to identify any potential risks.
Reviewing contracts
When buying a business, it is also important to review all of the contracts that are in place. This includes reviewing the lease agreement, supplier contracts, employee contracts, and any other agreements that are in place.
This will help you to identify any potential risks or liabilities that could come with the purchase of the business.
How Long Does Due Diligence Take?
The length of time it takes to do due diligence will depend on the size and complexity of the business you’re looking to buy. For a small business, you might be able to get away with doing your due diligence in a few weeks. But for a larger business, it could take several months.
Which Professionals Can Help With Due Diligence?
There are a number of professionals who can help you with due diligence, including accountants, lawyers, and consultants.
These professionals can help you understand the financials of a business, review legal documents, and provide advice on whether or not a particular business is right for you.
Assessing Your Due Diligence Findings
When you’re considering buying a business, it’s important to have a clear understanding of what you’re actually buying.
This means taking the time to review all of the financial documents associated with the business, as well as any other relevant information that will give you a better understanding of the business’s overall health, we’ve included a comprehensive checklist of areas to look at below.
Consider the Business’s Potential
It’s also important to consider the potential of the business you’re thinking of buying. This means looking at factors such as the current state of the industry, the potential for growth, and whether or not there are any major risks that could impact the business in the future.
Have Realistic Expectations
It’s important to go into any business purchase with realistic expectations. This means understanding that there is always some risk involved and that there is no such thing as a sure thing.
It’s important to have a solid plan in place for how you’ll operate the business and to be prepared for bumps in the road.
If you perform detailed due diligence, you’re likely to find something that you’re not keen on. You have to take things in the round.
Think in terms of a traffic light system – ‘red light’ issues might be big problems on the balance sheet, decreasing profits, shrinking customer bases etc.
But other issues, such as disputes, age of equipment, contractual terms etc, need to be thought through. They might not mean you need to walk away, they might actually help you negotiate a better price & deal terms.
Get Professional Help
When you’re assessing due diligence when buying a business, it’s important to get professional help. This means working with an experienced business broker or other professional who can help you navigate the process and understand all of the risks involved.
No matter how much prep you do, such as reading our detailed checklist below, you can’t replace lived experience. That’s why it makes sense.
Book a Free Consultation
Due Diligence Checklist
You don’t necessarily need to check everything on this list. It’s intended to cover as much as possible.
The simple rule is this – the larger the purchase, the more exhaustive you’ll want to be with the due diligence.
If you’re taking over a company that turns over a few hundred thousand pounds, there are less moving parts and risks compared to the acquisition of an audit registered business with 150 staff.
It’s a judgement call on your side about the level of scrutiny needed VS the risk and size of the business you’re buying.
Financial Information
- Annual reports
- Accounts and statements detailing cash flow
- Shareholders and their ownership percentages
- Expenses, debt, equity and any collateral
- Depreciation and amortisation processes
- Financial projections
- Fixed and variable assets
- Physical assets, including real estate and equipment
- Intellectual property
- Current tax paperwork
- Financial statements
- Any auditor’s correspondence
- Any tax or pension liabilities
- Capital structure
- Projections & budgets
- Stockholder Details
- Reserves for Foreign Exchange
- Any collateral used for debts
- Owner withdrawals
- Unrecorded liabilities
Current Market Conditions
- Products and services
- Values and culture
- Advertising campaigns and their effectiveness
- Published articles and press releases
- Marketing budgets
- Sales/marketing strategy documentation
- Revenue split by client
- Revenue listed by customer
- Sales broken down by channel
- Pricing, quotes, invoices and profit margins
- Gross margins analysis
- Sales reports covering products/categories/services
Contracts and Agreements
- Contracts with business partners, shareholders, suppliers or other third parties
- Details of company investments (bonds, marketable securities, etc.)
- Details on when contracts and leases are renewed and whether the terms change
- How credit terms with customers are structured
- Insurance policies and previous claims
- All tax returns
- Litigation issues
- Any loan or credit agreements
Operational Issues
- Age and efficiency of IT, software packages and other equipment
- Manufacturing, distribution and sales processes
- Licences and permits
- Any use of hazardous products
Employees
- Corporate structure and organisational charts
- Partners, consultants or freelancers, including finance and legal professionals
- Professional experience of senior board members
- Current employees, job roles and salaries
- Employee training details
- Employee benefits
- Bonuses & commissions
- Sick pay
- Holiday entitlement
- Overtime arrangements
- Copies of pension and profit-sharing plans, plus financial statements, if relevant
- Employment contracts
- Employee handbook and leave policies
- Onboarding and offboarding processes
- Employee benefits, including stock investment opportunities
- Pension plan policies and other benefits
- Employee complaints, disputes and compensation claims
- Payroll records
- Staff files
- Staff manuals
- Provide a list of current employees and independent contractors
- Employee rules of conduct handbook and safety policies
- Union arrangements
Tips for Getting Due Diligence Right First Time
The first step in getting due diligence right is to have a clear idea of what you want to achieve. What are your goals for the business? What are your key priorities? Once you have a good understanding of your goals, you can start to identify the areas that you need to focus on during the due diligence process.
Do Your Homework
Due diligence is not something that should be taken lightly. Before you start the process, it is important to do your homework and research the business thoroughly. This includes reading up on the industry, talking to other businesses in the same space, and doing a financial analysis of the business.
Identify the Key Risks
When buying a business, there are always going to be some risks involved. It is important to identify the key risks before starting due diligence so that you can assess whether or not they are acceptable. Some of the risks that you should consider include financial risk, operational risk, and reputational risk.
Hire a reputable advisor
One of the most important steps in getting due diligence right is hiring a reputable advisor. Your advisor should have experience in conducting due diligence and be able to provide you with impartial advice. They should also be able to answer any questions that you have and help you understand the process.
Be Prepared to Walk Away
If at any point during the due diligence process you feel uncomfortable or that the risks are too high, be prepared to walk away from the deal. There is no shame in walking away from a deal if it is not right for you. Remember, this is a decision that could potentially impact your life so it is important to make sure that you are comfortable with it.
Get Everything in Writing
Once you have decided to proceed with the deal, it is important to get everything in writing. This includes the purchase agreement, loan agreements, and any other relevant documents. Having everything in writing will help to protect your interests and ensure that everyone is on the same page.
Due Diligence - Final Thoughts
Buying a new business should mark the start of a wonderful new chapter in your life – the last thing you want is a nasty surprise after the sale has been completed and it’s too late to do anything about it.
That’s why it’s always better to ask more questions than you need to, rather than less.
Whilst you might not need to explore every avenue listed in this guide when you are checking out a company you wish to buy, you’ve at least now got a clear idea about the topics you need to be thinking about.
The checklist can help inform your conversations with an accountant or other professional that may be assisting you with the sale.