Diligence
The due diligence checklist
Nineteen checks, grouped by the kind of risk they uncover. For each one: what to request, what you are looking for, and what should make you stop.
Nineteen checks, four areas
Checklist structure, not completion or a risk score.
Due diligence starts after the seller accepts your letter of intent and runs until closing. Its purpose is to confirm that the business is what you were told, and to find what you were not told while you can still renegotiate or walk away. The workbench tracks all nineteen checks for each deal, and the due diligence tracker is a spreadsheet version.
Financial
- Three years of P&L and tax returns, reconciled. Request the returns and the internal statements for the same years. They should tell the same story. Stop if revenue on the statements is materially higher than on the returns.
- Quality of earnings reviewed. For larger deals, an independent quality of earnings review tests revenue, expenses and add-backs. For smaller deals, do a lighter version yourself: match twelve months of bank deposits to reported revenue.
- Receivables aging reviewed. Request a list of unpaid customer invoices by age. Old, uncollected receivables can make revenue look better than cash.
- Add-backs justified in writing. Every add-back needs a document. See What SDE is.
- Capital expenditure schedule reviewed. List major equipment, its age and replacement cost. Stop and reprice if large replacements are due soon and were not in the price.
Operations
- Key employee retention assessed. Identify the two or three people the business cannot lose. Learn what keeps them, ideally by meeting them before closing, with the seller's agreement.
- Operating procedures transferable. Are pricing, scheduling, quality and hiring written down? If everything lives in the owner's head, budget for a longer transition.
- Equipment condition verified. Inspect it, or pay someone qualified to. Compare it to the capex schedule.
- Supplier relationships transferable. Confirm key suppliers will continue on the same terms with a new owner.
- Customer concentration reviewed. Request revenue by customer for three years. Any single customer above about 10 to 15% of revenue is a risk to price, structure or protect with an earnout.
Legal
- Entity structure confirmed. Confirm who owns the business and what you are buying: assets or shares. See asset vs. stock purchase.
- Litigation disclosed and reviewed. Ask for any past, pending or threatened claims, and search court records yourself.
- License transfer requirements checked. Many licenses and permits are personal or need regulator approval to transfer. Confirm the timeline before setting a closing date.
- Lease assignment approved. Get the landlord's written consent to assign or a new lease, with enough remaining term to match your loan.
- IP ownership documented. Confirm the business owns its name, website, domain, phone numbers, social accounts and any software or designs.
Market
- Competitive landscape mapped. Who are the alternatives, and why do customers choose this business?
- Customer reviews audited. Read three years of reviews. Look for trends, and for how the business responds.
- Local demand assessed. Is the market growing, shrinking or changing? New competitors, regulation or development can change a local business quickly.
- Seasonality included in the model. Monthly revenue for three years shows the cash low points. Make sure working capital covers them.
Using the results
Every finding leads to one of four outcomes: confirmed, priced in (a lower price), structured around (a seller note, an earnout, a longer transition or a specific promise in the purchase agreement), or a reason to walk away. Record which one in the workbench so the final agreement reflects what you learned.