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 an investigation into the business or product you are interested in buying. You will conduct your due diligence before the transaction is finalized to verify if the acquisition is worth it.

When conducting due diligence, you will look at key issues of the business or product, including profits, financial risks, legal issues, and potential deal breakers. You will examine historical records and future projections.

How to do due diligence

Small business due diligence can be a long, complicated process. It involves digging through a business’s records, checking references, ensuring everything checks out, and searching for items the business might have hidden.

Don’t conduct business due diligence alone. Hire an accountant and a lawyer who have experience in this area. While you can certainly be involved and look over documents, it’s best to have professionals on your side. They know how to look for red flags that you may have missed on your own.

When you start the business due diligence process, you will sign a confidentiality agreement with the other business owner. By signing, you agree not to contact people or businesses for additional information about the business or product without the other business owner’s approval. This prevents others from prematurely finding out about the sale before it is finalized.

Next, go through a due diligence checklist with your accountant and lawyer to ensure you hit all parts of the due diligence process. Your lawyer or accountant might have a checklist, but you can create your own.

Due diligence checklist

When you do due diligence, you will look at several aspects of the prospective business or product. Below is a business due diligence checklist to help you work through the process. This checklist is geared more toward acquiring a business, but you can easily adapt this for acquiring a product. Also, make sure you work with your accountant and lawyer to make sure you add or remove any necessary steps.

Financial due diligence

Financial due diligence, also called accounting due diligence, looks at the business’s economic situation. You’ll look for consistency among accounts, assets, and liabilities. You’ll also look at historical trends, projections, and tax risks.

• Look at past annual and quarterly financial information, including:
  • Income statements
  • Balance sheets
  • Cash flow statements
• Review sales and gross profits by product.
• Look up the rates of return by product.
• Look at the accounts receivable.
• Get a breakdown of the business’s inventory.
  • How much inventory is on hand?
  • What is the value of the current inventory?
• Make a breakdown of real estate and equipment.
  • List the name, model number, and valuation of all equipment and furniture.
  • Note the size and current market value of land or buildings.
• Review past projections and actual results.
• Take a look at the owner’s future projections, including:
  • Quarterly and annual projections
  • Projections by product
• Inquire about the assumptions the owner used to make projections.
• Get a history of pricing policies and past increases.
• Ask for all business tax details.
• Retrieve a summary of debts and their terms.
• Get a summary of all current investors.
• Get a summary of all shareholders.