Due Diligence Before Buying a Small Business

Due diligence is something that can happen in the corporate world, but also if you’re considering buying or selling a small business. Sometimes a bigger company will buy a small business to expand, or you might be an investor.

Conducting thorough due diligence is essential, regardless of the specifics of your situation. The following are some of the primary things to know about due diligence, particularly when it involves a small business.

What Is Due Diligence?

If you’ve never gone through the process of due diligence before, on either the buying or selling end, it can be overwhelming, and you’ll likely need input from third-party experts or consultants.

If you have an interest in buying a business, you conduct due diligence to verify it is as it seems to be and that it will really make sense for you to buy it.

You have to take into account the fact that due diligence can be a lengthy process. Along with looking at financial statements and business records, you may also be contact references and other people who are involved or could provide you with relevant information.

At the start of the process, you’ll sign a confidentiality agreement, which means if you do get help from third parties such as accountants or lawyers, you’ll have to let the owner know and get their approval.

Types of Due Diligence

There are different types of due diligence that can be relevant to the buying or selling of a small business.

The area we think of most frequently is financial due diligence. This involves key financial elements such as any creditors or debtors a business may have, projects, margins, and sales pipelines. Financial due diligence can also encompass an analysis of variable and fixed costs.

Beyond that, taxes are something that needs to be looked at during the due diligence process. As a buyer or seller of a small business, you want to think about the tax liability.

Legal considerations during due diligence can include the following:

  • Lines of credit
  • Financing
  • Limited liability agreements
  • Company guarantees

Other legal considerations in due diligence are leases, purchases agreements, trademarks, patents, and trade secrets.

If you are looking at buying a small business, what about the customers? What are the current relationships with customers like, and how do customers buy from the business? Are they loyal? Are there areas where the customer base could be improved or could grow with the right strategy or not?

Specific things to look for with customer-related due diligence includes a comparison of first-time buyers to repeat buyers, peak buying times, and the most popular goods or services. Go through current marketing and see how much is being spent and how marketing campaigns perform.

Finally, among the types of due diligence is employee-related considerations. How dependent is the operation of the business on the owner and the current employees?

What do the existing employee contracts look like?

Market Factors

No matter how much digging you do into the specifics of a business itself before you make a buying decision, you also have to look at broader considerations such as doing a market analysis.

See what industry trends are, what demographics are, and what the future economic outlook might be with particular regard to the business you’re thinking about buying.

Who are the competitors, and where do they excel versus where do gaps exist?

Common Mistakes

If you’re thinking about buying a business, it’s important to learn from common mistakes and avoid them.

One of the biggest mistakes is also one of the most avoidable—don’t buy the wrong kind of business for you. During due diligence, look at what’s beyond the paper and think about you would be a good fit for the business itself. Does it personally hold appeal for you?

You also need to have a grasp of why the business is being sold. Sometimes a business owner may be less than forthcoming about their real reason for selling, and it’s up to you during the due diligence process to figure it out.

Finally, if you see serious red flags or issues within the business, don’t make the mistake of thinking you can come in and fix them. If you buy a business that requires drastic changes and in particular, changes to operations and employees, you are likely going to find that it becomes a financial drain and perhaps one that doesn’t pay for itself.