September 23, 2024
When purchasing a business, due diligence is the most critical step in the process. While the term may sound complex, it simply refers to the phase where you (1) verify the accuracy of the information previously provided and (2) ensure there are no hidden issues that could pose significant risks.
During this phase, you’ll meticulously examine the company’s books and records to validate financial data. Additionally, you’ll investigate relevant sources to uncover any undisclosed problems that could negatively impact the business.
At this point, it’s assumed you’ve made a written contingent offer to purchase the business, and both parties have agreed on the price and terms, likely after some negotiation. The deal now hinges on the results of your due diligence review.
Reviewing the Books and Records
Once your contingent offer is accepted, you gain access to the business’s complete financial records. You’ve likely already reviewed profit and loss statements and tax returns, but now you can ask the seller for clarification on any aspect of these documents. Don’t hesitate to seek their help in interpreting financial details—understanding these reports fully is crucial.
It’s also advisable to review additional records, such as bank statements to confirm deposits, monthly sales tax reports to assess revenue and seasonal sales trends, and quarterly payroll reports if you have concerns about wages. This stage is your opportunity to validate the data that informed your purchase decision.
Other Key Considerations
Beyond financials, due diligence involves evaluating key employees, legal and regulatory compliance, environmental factors, and lease agreements if the business operates from a leased property. Checklists for these areas are readily available online, but remember that buying a smaller business differs vastly from major corporate acquisitions; keep your focus practical.
In an asset sale, you’re purchasing selected assets without assuming the seller’s liabilities (unlike a corporate stock or LLC membership sale, where liabilities transfer with ownership). However, some obligations, such as unpaid payroll taxes, can follow the assets regardless of the sale type. Identifying and addressing any such issues is essential.
If everything checks out—and it usually does—you’re almost at the finish line. As astronauts might say near the end of a countdown, “We’re good to go.”
