The Monet Blog · Entrepreneurship

Small business due diligence checklist: what to verify before you buy

Financial, customer, operational, legal and tax checks to complete before closing on a small business — and the signals that mean you should walk away.

By Sankha NagChoudhuryNovember 11, 20268 min read

Due diligence is the period after a letter of intent when you confirm, with documents, that the business is what the seller described. It is tedious by design. Every hour spent here is cheaper than discovering the same problem after closing, when it has become yours.

Financial checks

The goal is to confirm that the cash flow you are paying for is real and will continue.

Compare three years of business tax returns with the profit-and-loss statements.
Tie reported revenue to bank deposits for at least twelve months.
Test every add-back the seller claims, with receipts.
Review accounts receivable ageing, payables and the working capital needed to operate.
For larger deals, consider an independent quality-of-earnings review.

Customers and revenue

Revenue that depends on a few relationships can leave with the seller.

Share of revenue from the top five customers, and whether contracts can be assigned to you.
Customer churn and how new customers are found today.
Pricing history, and whether prices have kept up with costs.

Operations and people

Ask what happens on a normal Tuesday without the owner in the building.

Owner dependence: who sells, who quotes jobs, who fixes problems.
Key employees, their pay compared with the market and whether they plan to stay.
Written procedures, software and the condition and age of major equipment.
Supplier relationships and any single-source dependencies.

Legal and compliance

Your attorney should lead this part; your job is to make sure nothing is skipped.

Entity documents, ownership and authority to sell.
Lien (UCC) and litigation searches against the business and the owner.
Lease terms, remaining length and whether the landlord must consent to assignment.
Licences, permits and certifications, and whether they transfer to a new owner.

Taxes and deal structure

Unpaid taxes can follow a business, and structure changes who carries old liabilities.

Confirm payroll, sales and income tax filings are current.
Ask your CPA and attorney whether an asset purchase or a stock purchase better protects you.
In an asset purchase, buyer and seller generally report the price allocation to the IRS on Form 8594, which affects depreciation and future taxes.

Signals to walk away

Some findings can be fixed with price or structure. Others cannot.

The seller resists providing records or bank statements.
Cash revenue that appears in the pitch but not on the tax returns.
Undisclosed liens, lawsuits or tax debts.
Key customers or employees who will not stay through a transition.

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