The Due Diligence period is one of the most important stages of buying any business. It’s the stage where you’ll thoroughly inspect the company, trying to uncover every piece of information that will help you make your final decision.
It’s also potentially the most time-consuming stage, too – but don’t let that encourage you to cut corners. If you are not thorough, you may find some unpleasant surprises hidden in the fine print after you’ve bought, or you might abandon the purchase of a good business altogether. Either way you lose, so do a complete job!
In this article we’ll walk you through the questions you should ask, and some of the red flags to look out for when you’re searching for a business to buy.
Due Diligence Checklist – Questions You Need to Ask
Due Diligence is not just a verification of the company’s financial statements. It’s an opportunity to immerse yourself completely in the business, and we’ve put together a list of some of the most important questions you’ll need answers to during this stage.
- Are the financial statements that you have received accurate?
- Is the inventory in “good and resalable” condition?
- What is the condition and value of the assets?
- How effective and committed are the employees?
- What is the overall picture of industry and the competition?
- What has the company done to market itself?
- How strong is the sales team?
- Will the company’s contracts continue under your ownership?
- What can you do to increase the revenues and profits?
- Based upon what you learn, does the business have a viable future?
- Does the business meet the criteria of The Ten Commandments?
Don't worry if you find this section of the guide a bit overwhelming - you won't have to do all of the things noted here for every single business you find. For example, if you are buying a pet store, there is no need for you to do the DD on the sales team. Or, if you are considering the purchase of an e-commerce company, then you will not require a thorough investigation of the Accounts Receivable. You should tailor this list to the business you’re investigating.
Tip: If you’ve found a business you’re thinking of buying, its easy to get swept up in the excitement. But it’s really important that, during the due diligence period, you gear your passion towards discovering everything you can about the business. Keep a clear head so that you can make a sound decision about its viability, and evaluate it as objectively as possible.
How Long Does Due Diligence take?
You will need an average of 20 business days (one month) to conduct effective Due Diligence. In larger and more complex deals, a 90-day period is common. You will need the help of an accountant and it is strongly suggested that you hire at least one person (friend, family) to help with the grunt work like counting inventory or chasing down information. One month seems like a lot of time, but it passes very quickly and the smaller the business is, the worse the corporate records and files usually are.
Make sure that all the critical documents required are prepared prior to your start date so you don’t waste any time. Your accountant/attorney should also have their own due diligence checklist, so compare yours to theirs and make sure you aren’t doubling any tasks. It pays to be highly organised during this stage, making sure to log any questions for follow up and breaking things down by department.
Remember – the seller may be trying to maintain confidentiality during this process, so you might not have the opportunity to talk to every employee, supplier or customer. You should lay out a timeline and try to investigate with their blessing. Be up front and let them know in the clearest terms that you’ll be snooping on them!
Do I need an Accountant for Due Diligence?
Your accountant must play the lead role investigating the financials. Unless you are purchasing a business that you are very familiar with or if you are an expert in this area, let a professional do the work. Meet with them beforehand and together you must assemble a list of everything that will be done. Review the timelines and be sure that there is no confusion as to when it will be completed and who is doing what. Negotiate a fee beforehand and give them plenty of warning ahead of time.
What Do I Need to Look at During Due Diligence?
So, with all that said – lets take a deeper look at the actual questions and investigations of the due diligence process. The short answer to the question above is – everything! But here’s a top line view of everything you’ll want to ask, and afterwards we’ll take a deeper dive into some of them.
- Financials
- Assets
- Sales
- Marketing
- Employees
- Systems
- Competition
- Customers
- Contracts
- Suppliers
- Legal and Corporate
Finances
Here’s a shocker for most buyers regarding the financial part of the Due Diligence period: it’s usually the easiest thing to investigate. Numbers don’t lie: people do. That means now isn’t the time to see if buying the business makes sense financially – you should have done that before you even sent a Letter of Intent. Your goal here is simpler: to reconfirm that the figures by which you made your decision are accurate.
If they aren’t, be prepared to work with your accountant to adjust your valuation of the business, and put in a lower (or sometimes higher) bid. You should also be verifying a business’ income statements, and taking random samples of its transactions and expenses to make sure they add up correctly. Looking at the business’ balance sheet is also essential. You must determine how long it takes the average account to pay its bills, because this will have a major impact on your cash flow.
Sales
Begin by having each salesperson “pitch” you the company’s products/program/services as though you were a potential client. Then, you will want to start asking them some questions: what do they do on a typical day? How do they obtain new customers? How long do clients typically stay? Do a handful of salespeople make most of the money, and could the business cope if they left during the change of management?
Your goal is to get an overview of what is being done, and determine how can it be done better. Is the potential with each client is being realized, and what options are available to build the sales force?
Marketing
The marketing strategy may not be clearly defined, especially if you are buying a small business. Unfortunately, many owners do not realize how critical this aspect of the business is. It does not matter if you are a one-person electrical contracting company or a Fortune 500 company: it’s all in the marketing. Here are some questions you might want to ask on the marketing side of things:
- Does the company have a marketing plan, and if so have they followed it?
- What has been successful, and what has failed?
- What were the costs of each campaign, and how much does the company sped on marketing each year?
- Does the company spend more effort on getting new customers or on increasing their volume with current clients?
- Is the company clear on what its strengths and weaknesses are, and do they communicate this to their customers and clients?
Competition
This is the most ‘fun’ part of Due Diligence. You get to play detective, and be a bit creative. You may be surprised to learn how little the business you’re investigating knows about the competition. Business owners tend to go into their own little world of running their businesses, and as the days and years pass by they may take their eye off the competition.
Have each salesperson and marketing employee put together the information they have about their competitors. Don’t do this collectively, but see what each one has on their own. It will tell you how informed they are about their competition, which often goes hand in hand with how effective they are. You could also get them to put together a competitive analysis which looks at the strengths and weaknesses of their competing businesses.
Tip: Another way to find out about the competition is to simply reach out to them and pretend to be a potential customer. Get your roleplaying shoes on and you’re likely to discover something new.
The Final Word
During Due Diligence, you can determine to the absolute best of your ability if this is a good business, and whether it conforms to The Ten Commandments. Once you verify the financials you must put all the other pieces of the puzzle together to see what you come up with. With all this said, don’t get so deep into the weeds that you end up rescinding an offer for a minor issue.
There is no such thing as a perfect business, but you should come away from your Due Diligence with the feeling that you have found a good one. With some creativity and passion, it can become great - and you’re the right person for the job!
This article has been adapted from How To Buy A Good Business At A Great Price, a course written by Richard Parker at RichardParker.com. To gain access to the full course, which walks through the entire process of purchasing a business in further detail, click here.
FAQs
What does Due Diligence mean?
The Due Diligence period is the phase of buying a business where you investigate its finances, operations and systems before committing to purchase it. It can be time-consuming, but it is crucial in helping make a decision.
How long is the Due Diligence period?
The due diligence period can take about 20 business days (one month) to be conducted effectively for small businesses. In larger and more complex deals, the due diligence period is commonly about 90 days.
What is Due Diligence money?
Due Diligence money will be any fees you have to pay when investigating a business before buying it. This will often be fees for lawyers, accountants, etc.
Do you get Due Diligence money back if it fails?
Generally speaking, no. The money you spend conducting Due Diligence on a business will come in the form of fees for lawyers, accountants, etc. You’ll need to pay them even if you don’t end up buying the business.
