How to Conduct Due Diligence When Acquiring a Small Business or Product

Are you considering buying a business to start your journey into small business ownership? Or, do you want to acquire another small business to expand your existing one? Or, do you want to acquire a product to add it to your business? If you answered yes to any of these questions, you need to know about due diligence and how it can inform your purchasing decision.

What is due diligence?

Due diligence is a comprehensive appraisal process conducted before entering into a business transaction—such as purchasing a business, acquiring a product, or investing in a company. The purpose is to verify all material facts, uncover potential risks, and assess the overall viability of the opportunity.

• Conducting Effective Due Diligence

  When conducting due diligence, it is essential to assess key aspects of the business or product under consideration. This includes evaluating profitability, financial risks, legal matters, and identifying any potential deal breakers. A thorough review of both historical financial records and future projections is critical to making informed decisions.

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  The Due Diligence Process

  Due diligence for a small business can be a complex and time-consuming endeavor. It requires a careful examination of business records, verification of key information, and an investigation to uncover any discrepancies or concealed issues.

  Engage Professional Support
  Due diligence should not be undertaken alone. It is highly recommended to retain the services of an experienced accountant and legal counsel. While your active involvement is important, professionals are trained to identify red flags and navigate areas that may be overlooked without specialized expertise.

  Confidentiality Agreement
  At the outset of the process, you will typically sign a confidentiality agreement with the business owner. This agreement prohibits you from contacting external parties for additional information without the owner’s consent. The intent is to maintain discretion and prevent premature disclosure of a potential sale or transaction.

  Using a Due Diligence Checklist
  Work with your accountant and attorney to follow a comprehensive due diligence checklist. Your advisors may provide their own version, or you can create a customized checklist tailored to the specific transaction. A structured approach ensures that no critical area is overlooked.

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  Sample Due Diligence Checklist

  The following checklist outlines key areas to examine during the due diligence process. While it is primarily geared toward acquiring a business, it can be adapted for product acquisitions as well. Collaborate with your accounting and legal team to tailor the checklist to your needs.

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  Financial Due Diligence

  Also known as accounting due diligence, this step involves evaluating the financial health and sustainability of the business. Areas of focus include:

  • Financial Statements

    • Review annual and quarterly financial reports:

      • Income statements

      • Balance sheets

      • Cash flow statements

  • Revenue and Profitability Analysis

    • Sales and gross profit breakdown by product or service

    • Return rates by product

  • Accounts Receivable

    • Aging reports and collection history

  • Inventory Review

    • Inventory levels and valuation

    • Inventory turnover rate

  • Assets and Equipment

    • Itemized list of real estate, equipment, and furniture (include name, model, and appraised value)

    • Market value and dimensions of any owned land or buildings

  • Projections and Forecasts

    • Review owner-prepared future financial projections:

      • Quarterly and annual projections

      • Product-level projections

    • Evaluate assumptions used in forecasting

  • Pricing History

    • Historical pricing strategies and any recent increases

  • Tax Review

    • Business tax filings and liabilities

  • Debt and Equity

    • Summary of outstanding debts and terms

    • Overview of current investors and shareholders

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  This structured approach to due diligence helps you identify potential risks and validate the business’s financial integrity before moving forward. Working with seasoned professionals ensures the process is handled thoroughly and strategically.

  Let us help you navigate this important phase with confidence and clarity.