What due diligence actually checks before you buy a business

People lose money on things they could have checked.

Due diligence has an intimidating name, and it is often treated as a formality performed late, once the price is already agreed and everybody wants to close. Done that way it finds nothing. Done properly it is simply the discipline of confirming the story before you act on it — and it is most valuable when it is still early enough to change the price or walk away.

Here is what it actually looks at.

The business exists and is in good standing

Start with the dullest check, because it fails more often than people expect.

Confirm the registered name and number, that the company is current with its filings, who the registered shareholders are, and who the directors are. The person selling you a business is not necessarily the person who owns it. The shareholding described over coffee is not always the shareholding on the register.

Where there are multiple shareholders, confirm that the ones not in the room have agreed to the sale. A deal signed by one of three shareholders is not a deal.

The person signing can bind the business

Authority is separate from ownership. A manager may run the business day to day and have no power to sell it. A director may need a board resolution. A company constitution or shareholders’ agreement may require unanimous consent for a disposal of this kind.

Ask for the resolution. If it does not exist yet, the deal is not ready to sign, however warm the conversation has been.

The numbers hold together

You are not auditing. You are testing whether the figures you were shown describe the same business you are being sold.

The most useful checks are cross-checks, because they are hard to dress up:

• Do the declared sales match the bank statements over the same period?
• Do the bank statements match the tax returns?
• Does the stated payroll match the number of people you can see working there?
• Does the debtors’ book age reasonably, or is a large share of it very old?
• Is there a single customer who makes up most of the revenue?

That last one is not fraud, but it is the risk that most often destroys the value of a small acquisition. A business where one customer is sixty per cent of revenue is a business whose value sits in a relationship you have not been introduced to.

What the business depends on, and whether it transfers

Most small businesses run on a handful of things that are not on the balance sheet: the lease on the premises, a distribution agreement, a licence, a permit, a key supplier account, a piece of financed equipment, two or three people.

For each one, ask the same question: does it survive a change of ownership?

• The lease may need the landlord’s consent to transfer, or may end.
• The distribution or agency agreement may terminate automatically on a change of control.
• The licence or permit may be issued to the company, or to a named individual who is leaving.
• The financed equipment on the floor may belong to a financier.
• The key staff may have no written contracts, or contracts you inherit in full, including accrued leave and years of service.

A business bought without its lease, its licence or its main supplier is not the business you looked at.

What is owed, and what is being claimed

Ask directly for a list of liabilities: loans, overdrafts, supplier arrears, tax arrears, judgments, disputes threatened or underway, guarantees the business has given for someone else’s debt.

Then treat the answer as incomplete, because it usually is. Liabilities are rarely concealed deliberately; they are forgotten, or not thought relevant. The useful follow-up is a written warranty from the seller that the list is complete and that anything omitted remains theirs.

How the deal is structured decides which risks follow you

Buying the shares of a company means buying the company whole: its contracts and its history, including the liabilities nobody mentioned.

Buying the assets means buying the specific things listed, and generally leaving the company’s history behind — although employees, licences and leases each have their own rules and do not simply follow the assets.

This choice has tax and legal consequences that a registered legal practitioner and an accountant should take you through. It is worth raising early, because it changes everything about the checking that needs to be done.

The report should be able to say no

Due diligence that only ever confirms what the buyer already hoped is not due diligence. A useful report says plainly what checked out, what did not, what could not be verified at all, and what each unresolved item would cost if it turned out badly.

Sometimes it kills the deal. That is the cheapest outcome it can produce.

This note is general information, not advice on your transaction, and it is not legal advice. If you want a business, partner or asset checked before you commit, that is work we do.