Buying a Business Due Diligence Checklist: A Step-By-Step Guide

Before you consider buying a business, you must conduct the necessary research to ensure your decision will deliver a reliable return on the investment.

Failure to do so can lead to unforeseen hidden costs, a lack of understanding of the business’s customer satisfaction, and an inability to overcome challenges.

To help with the process, we’ve created a due diligence checklist that covers everything from analyzing the market to assessing the business operations and physical assets.

What Is Due Diligence?

Due diligence is the process of verifying and appraising a business to determine whether or not it is a worthwhile investment.

Whether you’re buying a business with no money or have plenty of capital, due diligence is essential for gathering facts to make an informed decision.

It allows the buyer to establish information on the business’s assets and liabilities, its commercial potential, and the viability of the purchase price.

The due diligence process varies in duration and complexity depending on the company, but it applies equally to the purchase of solopreneur and entrepreneur businesses.

It can be conducted independently or with the assistance of professionals who offer consulting agreements on various aspects of the research.

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The Importance Of Due Diligence

Due diligence is necessary whether you’re considering investing in a great small business or purchasing a tech firm offering cutting-edge B2B solutions.

In addition to allowing you to make a fully informed decision, due diligence is essential for various other legal, financial, and operational reasons.

Here are some other factors that make due diligence a vital part of the process of purchasing a business:

• Identifying the established relationship the business has with its existing customers and suppliers.
• Providing a detailed overview of expenses and profit margins to attract potential investors.
• Assessing the organization’s compliance with government regulations and standards at the federal, state, and local levels.
• Determining the business’s current sales and marketing strategies and how this will impact future growth initiatives.
• Identifying the strengths and weaknesses of competitors and how these can be used to drive the business’s development.

Due diligence covers many other aspects of business acquisition, ranging from understanding the company’s accounting methods to the associated tax liabilities.

Let’s break down these and more crucial aspects of the due diligence process in more detail.

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Buying A Business Due Diligence Checklist

Now that we’ve outlined the importance of due diligence, it’s time to break down the full process to ensure you’re fully prepared to buy a business.

Follow this due diligence checklist and gather all the vital information needed, from the business’s financial statements to required insurance coverage and more.

Step 1: Check The Organization’s Standing

The first step in performing due diligence on a company is to check whether it is in good standing and owes no state taxes.

This can be done for all types of companies, whether they’re service businesses for consumers or B2B companies providing support for corporate interests.

American-based investors can do this by heading to the Secretary of State’s website and searching for the business they’re considering buying.

Here, information about the company’s status is available through a search, listing it as “active” or “in good standing” for those with good records.

On the other hand, if a company is not in good standing, it may be listed as “non-compliant” or “delinquent.” raising red flags for the viability of the purchase.

The Better Business Bureau also provides reliability reports for companies and information on an organization’s standing.

Step 2: Analyze Financial Information

The next step in the due diligence checklist is to acquire and thoroughly assess any publicly available financial information about the business.

Audited financial statements, along with more recent unaudited statements and comparable statements from the prior year, are a great starting point.

If publicly available, you can also check the business’s credit report, capital budgets, strategic plans, and analyst reports.

You can also review the relevant accounting methods and analyze the available data for accounts payable and accounts receivable.

Likewise, tracking down information about existing business operations and inventory management can be invaluable for assessing a company’s practices.

This information is typically available for all business types, from subscription businesses to brick-and-mortar stores serving the public directly.

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Step 3: Assess Business Assets

Just as when putting together a small business startup checklist, you should have a clear grasp of all its assets when buying a business.

This includes physical assets that the business has acquired since it began operation and how these physical assets relate to aspects such as product inventories.

You can request access to the business’s inventory management system to view the information and assess its overall value.

Such assets can include physical machinery and tools, computer equipment, furniture, and other core office supplies, allowing for the verification of its current value.

If the business uses a fleet of vehicles, for instance, they operate delivery services, these cars, vans, and trucks are also classified as physical assets.

These should also be checked for age and current value, VINs, and any other relevant data that might impact their total value.

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Step 4: Evaluate Real Estate

Real estate assets are also core to a business’s successful operations and must be evaluated as part of the due diligence checklist process.

This is particularly vital for anyone considering purchasing an international business with worldwide properties, such as offices and warehousing.

You can start by accessing a schedule of the company’s business locations and copies of any real estate leases, mortgages, title policies, and deeds.

This information can then be supplemented with other related documentation covering any surveys, zoning approvals, and applicable real estate permits.

You should verify that the properties have a clear title of ownership, factoring in any land owned around the business real estate.

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Step 5: Review Intellectual Property

Reviewing intellectual property is also an essential part of the process when considering purchasing a business and centers around patents and trademarks.

The United States Patent and Trademark Office manages intellectual property for businesses and provides a database of this information for you to check.

Aspects of intellectual property that are relevant to research include all past and current patent applications and trademarks filed by the business since its inception.

It also covers the schedule of copyrights, work-for-hire agreements relating to these factors, and agreements with consulting firms and other related entities.

Additionally, a business’s brand elements, including associated slogans, can be classified as registered trademarks protected under the law.

Before considering the purchase, you should obtain copies of any consulting agreements, patent clearance documents, and recorded claims against the company regarding intellectual property.

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Step 6: Determine The Employees & Employee Benefits

While the best solopreneur businesses don’t require employees to run, most companies hire staff to help manage the daily business operations.

Employees represent many of a business’s operational costs, from their salaries and any benefits paid to health insurance coverage and other outgoings.

This means you need to have a clear view of the business’s workforce and how each individual impacts performance to assess the viability of the purchase price.

A complete list of the key employees and related employee benefits, positions, salaries, and insurance policies should be reviewed.

Likewise, any employee disputes, such as allegations of wrongful termination and labor disputes that have required arbitration, should also be investigated.

Analyzing the company’s insurance claims history and personnel handbook will also give you invaluable insight into the business’s health.

While this process is less relevant for small businesses that run themselves, most will hire key employees with whom you’ll work should the purchase go through.

Step 7: Assess Any Legal Issues

Verification of the business’s legal issues is also vital before deciding whether to purchase a company and take over its operations.

This begins with checking for any current litigation against the company, such as any claims for damages and the current status of these claims.

Past legal litigations against the company should also be researched, covering the previous three years and settlement agreements, decrees, and legal judgments.

Likewise, you should research any current or past legislation filed by the company and any other broader legal issues they’ve been involved in.

This can include legal matters relating to safety precautions, or lack thereof, and how new regulations may have impacted the smooth running of its operations.

While this is especially significant for companies such as medical transportation businesses, it shouldn’t be overlooked for other, more mundane business types.

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Step 8: Check Licenses & Permits

Many different types of licenses and permits are required for companies, from rental businesses to local stores, coffee shops, and restaurants.

Therefore, verification of these licenses and permits is an essential aspect of a due diligence checklist, ensuring everything is above board before making the investment.

Some of the standard licenses and permits required in the United States include:

• Business license: Proof of identity and ownership and typically required to legally operate in any American state, city, or county, and should be made available to potential buyers.
• Health and safety permits: If you’re considering purchasing a business that serves food and drinks to customers, you’ll need the relevant permits.
• Fire department permits: Businesses handling flammable products or chemicals must be up to date on associated permits to alleviate the fire risk.
• Federal licenses: Some businesses may require approval and regulation from federal departments, such as the Bureau of Alcohol, Tobacco, and Firearms or the Securities and Exchange Commission.
• Liquor license: If you run a restaurant or bar, you will need the appropriate liquor license and other health and safety permits related to food preparation.

By conducting thorough research in advance, you can ensure all licenses and permits are acquired and up to date before you decide to purchase the company.

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Step 9: Understand Environmental Regulations

Environmental regulations in the United States must be strictly adhered to and regulated through the Environmental Protection Agency.

The nature of these regulations and protocols varies from one business sector to the next and should be fully understood as part of the due diligence process.

For example, if you’re investing in a food truck business, these regulations will differ from those of companies focusing on manufacturing or construction.

Some of the key environmental regulations to bear in mind, depending on the business type, include:

• Clean Air Act: This regulation determines whether or not a company meets the EPA’s national air quality standards at the federal level.
• Resource Conservation and Recovery Act (RCRA): If the company produces hazardous waste that requires disposal, it must adhere to the standards established under the RCRA.
• Occupational Safety and Health Act (OSHA): All businesses with employees must implement the necessary measures to protect them from potential harm and hazards and promote safety in the workplace.

Compliance with these standards is mandatory, making this another crucial step in the due diligence checklist that shouldn’t be overlooked.

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Step 10: Determine Tax Liabilities

Lastly, a clear understanding of existing and future tax liabilities will further help you to assess whether purchasing the business is a sound investment.

You should assess the business’s tax returns over the previous three years, along with tax settlement documents, state sales tax returns, and employment tax filings.

This information will give you a clear view of the company’s current position, making improving the tax accounting process easier should you move ahead with the purchase.

Additional information to verify includes previous excise tax filings, any tax liens on record, and any available revenue agency reports.

An accountant or tax lawyer should also review this information thoroughly before the purchase is made to guarantee that everything is legal.

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Summary

Purchasing an existing business requires thorough research to ensure your investment delivers high returns and justifies the investment.

Following this due diligence checklist, you can make a fully informed decision and be prepared to manage the company and its employees once the acquisition is complete.

You can perform your own due diligence or hire professionals with relevant business and legal expertise to help you manage the process.