Due Diligence Checklist for Buying a Business
While buying an already-established business usually calls for a high upfront investment, it comes with upside.
An existing business will already have a customer base, which translates to immediate cash flow. The existing track record will also make it easier to assess its performance, and its financial history will give a clearer picture of its profitability.
Buying a business may be easier than starting from scratch but it still carries risk.
Why Have a Due Diligence Checklist?
A due diligence checklist will help minimize your risk.
The checklist involves getting a clear picture on the business’ legal structure, finances, vendors, employees, profits, etc. Without doing so, you won’t be able to identify the potential risks associated with the business you’re buying and may not be able to verify the seller’s claims and match what’s being said to what’s written on paper.
Who You Need for Your Due Diligence Checklist
You don’t have to go through your due diligence checklist alone if you don’t have prior experience in buying a business. You can create a team to help you go through the process faster and with better efficiency.
You could use the help of lawyers, accountants, business mentors, and financial advisers. They’ll help you review sensitive documents and provide valuable advice.
What to Include in Your Due Diligence Checklist?
Any due diligence list for buying a business should contain some essential information. Here’s everything you should include in your list:
Financial Information
Before buying a business, you need to have a full view of its financial information.
Audited financial statements and reports (ideally, a minimum of three years)
Letters and replies from auditors for the previous 3–5 years
A schedule of inventory
A schedule of debts and contingent liabilities
A list of accounts receivable and accounts payable
Tax returns (ideally, a minimum of three years)
A full report of the business’ internal control procedures
A report of changes in accounting processes for the previous 3–5 years
All capital budgets, projections, analyst reports, and strategic plans (if available)
A report of variable and fixed expenses
Analyst reports (if available)
Gross margins analysis
The business general/bookkeeping ledger
A report of amortization and depreciation methods
Customer Information
To accurately assess the potential profitability of the business you’re buying, you need to have a transparent view of its customer information.
A list of the largest customers of the business in terms of sales
Full report of sales in the previous two years
All supply and service agreements of the business
A full list of all unfilled orders
A description of the purchasing and credit policies of the business
A report of all running marketing plans and advertising programs, along with a list of printed marketing materials
An analysis of the business’ competitors
A report of lost major customers during the previous 2–3 years
Any relevant market research reports and surveys
Employee Information
You can’t buy a business without having full information on its employees, their salaries, and their benefits. Employee benefits are among the largest expenses you’ll be dealing with as a new business owner, so you’ll want to be prepared.
A full list of employees, their positions, and their salaries
Full information on all employee welfare benefits and health benefits
A list of all employee bonuses paid during their years of service
Full details of qualified and unqualified retirement plans
All agreements between the business and any employee, including consulting, employment, nonsolicitation, nondisclosure, and non-competition agreements
A copy of all current HR policies of the company
Full information on any outstanding or past legal issues with current employees, including allegations of harassment or wrongful termination (for a minimum of three years)
Full information on grievance procedures and labor disputes, whether they’re settled or still pending (for a minimum of three years)
The claim history of unemployment insurance and worker’s compensation
Resumes of senior managers and key employees
An analysis of the business's employee turnover
Full details of the business’ hiring process
Schedule of stock options and stock purchase plans
Taxes
You can’t assess whether the business you’re buying is a good investment if you’re not fully aware of its current and future tax liabilities.
If you have no prior experience in judging the tax situation of a business, it might be wise to consider hiring a lawyer to review the information and give you a proper opinion.
All income tax returns of the previous three years (Federal, local, state, and foreign income, if available)
All sales tax returns for the previous three years
All tax settlement documents for the previous three years
All employment tax filings and excise tax filings for the previous three years
All audit reports and revenue agency reports
Full information on any outstanding tax liabilities and tax investigations
Tax liens, if available
Insurance
Before becoming the new owner of a business, you’ll want to make sure its insurance policies offer enough protection to prevent significant monetary damage.
You’ll also need to include the insurance premiums in your operating budget, so you should be fully aware of them.
Copies and timeline of the business’s insurance policies, including personal and real property, errors and omissions, product liability, worker’s compensation, directors and officers, and general liability.
Copies and timeline of any other insurance coverages of the business.
A timeline of the business’s insurance claims history (for a minimum of three years)
Licensing & Permits
If you’re buying a business that requires permits to operate, make sure you have these documents before buying it:
Copies of all permits, consents, and government licenses associated with the business
All documents related to proceedings from any regulatory agency.
Legal & Accounting Matters
You may need a lawyer to help with the legal matters of your new business.
Copies of any agreements in place that put certain restrictions on assets
Copies of all letters with any authorities or regulatory agencies
Copies of any contracts that restrict the right to conduct business
All contracts with obligations (eg. indemnification)
Summary of the compliance program
Confirmation that the business isn’t restricted from operating under any regulations
List of all areas where the business is legally allowed to operate
Qualification to do business from the incorporation state
All nondisclosure and noncompetition agreements that the business is part of
All contracts and letters of intent from any acquisitions or mergers over the last five years
Any bank financing arrangements or loan agreements in place
Physical Assets
If the business you’re buying owns physical assets, here’s the data you need to understand the depreciation value of these assets:
All equipment leases
All UCC filings
A schedule of all fixed assets and their locations
A schedule of purchases and sales of capital equipment (for a minimum of three years)
Intellectual Property
Intellectual property is any intangible property that’s most likely a result of creative work, like a copyright.
The business you’re buying will likely have some sort of intellectual property, so here’s what information you need to know before finalizing the purchase:
List of all patent applications of the business (past and current)
List of all trademarks and trade name applications (past and current)
A schedule of copyrights
A schedule of trademark and trade names
List of both domestic and foreign patents
All patent clearance documents
All agreements for work-for-hire
Copies of any consulting agreements or licenses of intellectual property from or to the business
A summary of all claims issued against or by the business regarding intellectual property
Extra Steps to Take Before Buying a Business
Though the due diligence checklist is necessary and will help you prevent potential legal issues related to the business you’re buying, it’s not the only thing to prepare before finalizing the purchase.
Here are extra steps you need to take beforehand:
Valuate the Business
Generally, you can valuate a business based on its earnings and expected cash flow—this method is more common in businesses with a higher value than that of their assets alone.
Or, you can valuate a business based on its assets, which mostly works for businesses that deal with assets rather than operations (eg. real estate).
Assess the Assets
Before becoming the new owner of a business, you should have an accurate assessment of its fixed assets and inventory.
Make sure to find out whether there’s an outstanding loan related to any asset and if there’s a service contract or a limited warranty for it.
If the business owns equipment that is nearing the end of its life, you need to know its eventual replacement cost. It also helps to understand the maintenance process of this equipment and how often it needs major maintenance.
Negotiate an Offer
After going through your due diligence checklist, you should know the true worth of the business you’re buying and whether it’s a profitable proposition. This should allow you to correctly valuate the company and negotiate an offer that suits you.
Final Thoughts
Before buying a business, you have to go through this due diligence list to correctly assess its profitability, find out if it’s an attractive proposition, and anticipate potential costs or risks related to owning it.
The list includes collecting documents related to the business’s financial information, tax situation, physical assets, legal matters, and information on its employees and customers.
If it’s your first time buying a business, it’s highly recommended to reach out to a professional team who can help create your due diligence checklist and ensure you make the right decision and negotiate the best offer.
