5 Ways to Perform Due Diligence Before Buying a Business featured

June 16, 2022

5 Ways to Perform Due Diligence Before Buying a Business

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5 Ways to Perform Due Diligence Before Buying a Business

Unconventional Acquisitions

June 16, 2022

So…now that you’ve found a business you’re interested in buying…it’s time for the real work to begin.

After doing deals for over fifteen years, I’ve learned a thing or two about how to spot a good deal, and what questions to ask so you can make sure you’re making a savvy investment.

 I’d say that due diligence is by far one of the most important parts of the dealmaking process, but it’s also one of those that people are the most intimidated by.

That’s why we pulled together this checklist for you. It’s not meant to go in order, and it’s definitely not meant to replace your current process, buuuuuut…if I had to start all over and do a deal for the first time, these would be my non-negotiables to the dealmaking and due diligence process.

Here are the key things you’ll want to include in your due diligence process:

1. Start with a basic list of numbers you need from the current business owner. 

At some point, you’re going to want to make sure that you’re getting down and dirty with the numbers. 

But before you go asking for years worth of tax returns and access to every spreadsheet in their Google Drive, keep this in mind.

When you get to the early stages of the dealmaking process, you’ll want to be light-handed and reasonable with what you’re asking of the business owner. 

After all, they’ve still got a business to run on top of the M&A conversation you’ve just added to their plate. 

You’ll also want to show that you’re willing to be a sound partner during this part of the process (as opposed to someone who’s just going to show up and tire kick their deal to death).

One thing here if you’re new to dealmaking… It can be extremely easy to feel like you need to go through hours of research before approaching a business owner or doing a heavier lift on due diligence. Do not do this. 

It’s better to get a basic list of numbers that you’ll need before opening up the conversation, and then do a deeper dive once you’ve reached the due diligence stage. 

The numbers we recommend asking the current business owner for during your initial conversations are:

  • Financials (i.e. annual revenue, monthly recurring revenue, etc.)
  • Cash flow (i.e. profit/loss, profit margin, expenses, and income streams, etc.)
  • Expenses (i.e. monthly and yearly expenses on equipment, labor, maintenance, etc.)
  • Assets (i.e. equipment, real estate, machinery, etc.)

Whether you have a sales team helping you research and perform due diligence (or you’re going at it alone), you’ll want to flag anything in your initial numbers round-up that requires a follow-up or additional information that you can ask for in detail later on in the process.

2.  Get down and dirty with the numbers if it passes the initial sniff test. 

Once you’ve got a good idea of the overall financial situation, you’ll want to dive deep and get more information and financials from the business owner. 

Here are the must-haves on our list of what to ask for:

  • Three to six years of financials
  • Expenses, broken down monthly
  • Revenue/income, broken down monthly 
  • A list of hard assets (brick and mortar business) and valuations
  • A list of online assets (e-business) and valuations
  • An in-person visit to review the business and location
  • Information about the lease, if applicable
  • An overview report or summary of the current state of the business

We also highly recommend going to visit the business in person during this stage of due diligence. This will help you get additional information about the business, the owner, the location, the team, and many other things that you just can’t see on paper. 

If you can’t travel to the business but know someone trustworthy in the area, consider asking them to stop in on your behalf and get an initial read on the business. 

3. Send over an official letter of intent.

The business owner you’re working with may ask for you to create a non-binding letter of intent. 

This is just a fancy way to lay out some of the numbers you would be interested in, and if it looks good to the business owner, then theoretically you would make an offer to buy their business. 

If you’re writing a letter of intent, one of the critical pieces we cannot recommend enough is to include a general timeline and outline of the process. 

If you can give the business owner an idea of any major milestones, project deadlines, or checkpoints (and stick to them), you can help make this process easier for them and for you, too. 

4. Prepare to go in-depth for the due diligence journey. 

Next, you’ll want to start piecing together all of the information you’ve received. 

This is the step that most people are usually the most intimidated by, but it can also be the make-or-break moment of knowing if a deal is a good fit for you or not. 

One thing to keep in mind here— that we also see a lot of newbies get wrong—is overcomplicating this stage of the process, especially if the business is at the $500k to $1 million revenue mark. 

When a business is at this stage, there’s a good chance that there will be some things in the due diligence process that you may not actually need. 

This part of the process is really about understanding three key elements:

  • Are the financials real? 
  • Do you understand the risks of buying?
  • Do you understand the liabilities? 

A good rule of thumb is that the smaller the business is, the less complex these questions and their subsequent answers are likely to be.

I’ve bought many businesses in the past where the financials worked out and I didn’t need all of the bells and whistles and complicated spreadsheets to be able to get the information I needed.

The devil is always in the details, but the true key to doing your due diligence is understanding what the real financial picture looks like of the business you’re interested in buying. 

The same goes for keeping in mind the trajectory that the business has experienced.

For example, if a business that was previously churning out $100-200k in revenue a year suddenly jumps to $1 million or more in a year, its accounting department maybe hasn’t fully caught up yet to that level of growth. That means that their books may not be sparkling clean (at least, not yet).

P.S. We created a master checklist of every single question you’ll need to ask during this stage of the due diligence process in our small business buying course

6. Get your business buying team involved early. 

If you’re interested in buying a small business, then you’re gonna need a team to do it.

The two most important team members you should have sourced and in your back pocket are an attorney and an accountant. 

As you move through the due diligence process, you’ll want to make sure your attorney has looked over your letter of intent if you need it.

It’s also much easier to get your accountant involved while you are sussing out the numbers and financials earlier in the process, especially if numbers are not your strength.

You may also consider hiring a sales rep who can help you screen potential deals for your basic numbers before you start to get too involved in the process if you’d rather go that route. 

5. Consider checking the business’s credit report before you buy. 

When you buy a business, you are also taking on any of its current liabilities and assets including problems that you might not be aware of like unpaid bills that are being reported to credit reporting agencies. 

If you’re interested in running a credit report on a business you are reviewing during the due diligence process, we usually recommend checking out Experian Business Credit Advantage, Dun and Bradstreet, or Equifax.

If you’re brand new to the concept of boring businesses, you’re definitely in the right place. Here’s a list of our favorite boring businesses to buy so you can diversify your portfolio and create a plan for inflation or economic downturn. 

Want to spend LESS time chasing down bad deals and MORE time actually enjoying buying businesses in the boring? We’ll help you figure out which type of business to buy next, plus how to make your process smooth and streamlined, in our online course for small business buyers

…or if you’re really serious about investing in small businesses, you should probably head over and join our mastermind

Yours Unconventionally,

Codie & Ryan

Co-founders – Unconventional Acquisitions

If you want to learn more about how to find and buy businesses, check out these articles👇

You can also register for the course here OR if you are serious about buying a small business, join our mastermind.

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