Buying a business is an important decision, one with potentially far-reaching implications. Play it right, and you can set yourself up with a rewarding venture and secure your financial future. Get it wrong, however, and you may find yourself in financial and personal ruin. While hard work and smarts invariably play a role, much of your success or failure depends on choosing the right business. Choosing the right business, in turn, often largely rests on your ability to successfully navigate the due diligence process. 

In this article, we discuss the following aspects of due diligence:

• Understanding the process
• Technical aspects
• Legal aspects
• Operational aspects
• Financial aspects
• Tips for navigating the process
• Enlisting help for success

Related Article: How To Determine The Value of a Small Business

Understanding Due Diligence

Buying a small business requires many different steps. These include:

• Finding a worthy business to buy
• Negotiating with the seller
• Making a successful offer
• Signing a letter of intent
• Completing due diligence
• Drafting and signing the asset purchase agreement
• Closing the deal

While each of these steps is important for a successful acquisition, due diligence stands out. When you buy a business, you need to have a high level of confidence that the business will perform as you expect it to. Once you own it, you don’t want to encounter any unpleasant surprises about the business that could impact its profitability. 

Due diligence is your opportunity to thoroughly examine the company and verify that all the information the seller presents about it is correct. During the process, you are allowed—and encouraged—to comb through the company’s records or ask the seller questions in order to verify its performance.

Without a thorough process, you can’t really be sure the business performs as advertised. The seller could be telling the truth, but they could also be hiding unflattering aspects. If they are, this is your chance to find and reveal them. 

“Due diligence is your opportunity to thoroughly examine the company and verify that all the information the seller presents about it is correct.”

The different components of due diligence

Due diligence can be an exhausting and time-consuming process. To be done well, you must complete different types of due diligence on the company. Each type serves to evaluate different aspects of the business. They include:

• Technical
• Legal
• Operational
• Financial

Below, we will review some of the things you should cover in each of these categories. 

Technical Due Diligence

As its name implies, technical due diligence is your opportunity to investigate and verify the technical components of the business. This could include:

• Digital security
• Technical infrastructure
• Code quality
• IT capabilities

Depending on your technical skills, you may need to hire outside help to do a good job. We will discuss this more later on. 

Technical due diligence allows you to make sure all technical aspects of the business are as represented by the seller. It is your chance to find flaws, identify potential risks, and estimate future performance. 

“Legal due diligence is your opportunity to make sure the business is strong and healthy from a legal standpoint.”

Legal Due Diligence

Every business exists within a legal framework. If a business has incomplete documentation or breaks laws, its future could be in jeopardy. Legal due diligence is your opportunity to make sure the business is strong and healthy from a legal standpoint. 

This includes checking to make sure the business has all necessary formation documentation, including articles of incorporation or business registration documents. It is also your opportunity to evaluate all contracts with suppliers, vendors, and more. Additionally, you will want to examine any sales contracts, purchase agreements, or distribution agreements.

Lastly, you will need to evaluate whether the business has any outstanding lawsuits against it or is at risk of future lawsuits (patent infringement, etc.). Given the complexity of a thorough legal analysis, it may pay to work with an experienced business attorney when completing legal due diligence. 

Operational Due Diligence

During operational due diligence, you investigate and analyze the business’s operations. This includes the business model and processes, the competition, and the overall market. It is your opportunity to get a clear idea of how the business works and the environment in which it operates. During this process, you may want to analyze the company’s:

• Product development and supply chain processes
• Marketing plan and operations
• Pricing structure and discount offers
• Standard operating procedures

In addition, you will likely want to:

• Conduct a competitive analysis
• Learn about the market and industry trends
• Analyze industry profit margins
• Identify customer patterns (seasonality, etc.)

Again, you don’t want to buy the business only to discover surprises afterward. Be sure to familiarize yourself with key business processes and the environment in which it operates. 

“You don’t want to buy the business only to discover surprises afterward.”

Financial Due Diligence

Lastly, you must thoroughly analyze the company’s finances to ensure it is performing how you expect it to. This process, known as financial due diligence, is one of the most important steps of the entire process. 

Financial due diligence requires you to study the company’s financial statements, bank records, and third-party documentation to make sure the numbers check out. It is one thing for a business owner (or their accountant) to claim they made $100,000 in sales last year. It is another thing entirely for you to verify this claim by checking it against actual bank records. 

As you can imagine, checking and verifying all financial information can be an in-depth process. Given the detail and complexity involved, many buyers find it helpful to work with an experienced accountant during this step. 

“Checking and verifying all financial information can be an in-depth process.”

Tips for Navigating Due Diligence

Below, we discuss several tips for navigating the due diligence process. 

Identify key issues to address

Before you begin, it can be helpful to identify the key issues you need to address. While some of these issues remain the same regardless of the business you are buying, some may vary from business to business. In addition, each business model (ecommerce, SaaS, content site, etc.) will have different issues to investigate. 

Create a due diligence checklist

Once you have identified the key issues to address, make a thorough due diligence checklist. This will help keep you organized and drive the process forward. As you complete each item, check it off and move on to the next step. 

Your checklist could include tasks such as:

• Verify invoices
• Evaluate bank statements to make sure they match accounting records
• Verify vendor relationships
• Check website traffic numbers
• Check conversion rates
• Verify legal documentation
• Analyze legal risks

This is just a limited sample. It may help to divide your list into different sections for legal, financial, operational, and technical due diligence. Then, in each section, include specific, actionable items to check off. 

Move forward but take your time

Due diligence requires you to take in and analyze a huge amount of information. It is important to be thorough in your analysis so as not to make mistakes. Many buyers either skip over important steps in order to complete the process or get bogged down in analysis paralysis. 

It is best to strike a middle ground. Do the work, be thorough, but continue to move forward toward completion. Understand that it will take time and hard work, and show up prepared to put in the hours. 

Enlisting Help to Succeed in Due Diligence

As we’ve mentioned, many people find it necessary to enlist the help of due diligence experts to complete the process responsibly. There are several kinds of professionals you may want to consider bringing on board to assist you. 

Business brokers

Business brokers are individuals who help people buy or sell businesses. Given the complexity of the transaction process, they are there to help you navigate each step of the way. 

Having someone on your team who has been through due diligence countless times in the past can be invaluable. They will know what questions to ask, what information to seek out, and how to negotiate with the seller. Since so much is at stake, having an experienced business broker on your team can make the difference between choosing a worthwhile business and winding up with a lemon. 

“Having someone on your team who has been through due diligence countless times in the past can be invaluable.”

Due diligence experts

As we’ve discussed, some areas of due diligence require highly specialized and technical knowledge or skills. Whether you are analyzing the legal framework of the business or evaluating complex IT infrastructure, there are some tasks that nobody but an expert could reasonably complete. 

Depending on the complexity and nature of the business, you may want to enlist the help of a(n):

• Business attorney
• Technical expert (IT professional, etc.)
• Accountant

“By using a team approach, you gain confidence in your purchase, knowing you are unlikely to encounter any nasty surprises once you take over ownership.”

Your business broker will be able to determine when it is worthwhile to bring an expert on board. In addition, they will likely be able to recommend specific qualified individuals when the time is right. By using a team approach, you gain confidence in your purchase, knowing you are unlikely to encounter any nasty surprises once you take over ownership. 

Conclusion

Due diligence is a complex yet highly important part of the acquisition process. In essence, it is your last, best chance to verify the business you are buying and ensure a profitable purchase. By understanding the process and knowing where to turn for help, you can increase your chances of creating an effective approach and ensuring your success.