Due diligence is the process of investigating a business prior to sale.
As a buyer, it's your job to conduct a thorough and comprehensive due diligence process that covers all of the important aspects of the business before you sign on the dotted line. The seller will provide any information you request, but the ultimate responsibility for leaving no stone unturned falls squarely on your shoulders.
If you haven't performed due diligence before, the sheer magnitude of the process can be overwhelming. Hundreds of details – both large and small – have to be addressed before your investigation can be completed with any degree of certainty. Even due diligence experts sometimes find themselves fighting for air, especially if the company being purchased is large and complex.
To maximize your due dligence effectiveness, you're going to need to prioritize your due diligence checklist. By sequencing your due diligence tasks, you can avoid wasting time and energy. If high priority items don't pan out, at least you will save the time you would have spent verifying less critical information.
- Financials. Begin the due diligence by asking to see the most recent financials as well as financial/tax documents for the past five years. Although it's not an absolute necessity, we recommend outsourcing financial review to an accountant who has the expertise to tell you if the numbers just aren't adding up.
- Gross misrepresentations. If you're basing your buying decision on a handful of critical claims the seller has made about the business, be sure to check them out early in the due diligence process. Even a single gross misrepresentation is a good enough reason to walk away from the sale.
- Undisclosed liabilities. Sellers are required to disclose liabilities (e.g. judgments, debts, pending litigation, etc.) to buyers. If the due diligence process reveals any undisclosed liabilities, it's a problem because you don't know how many more liabilities may be lurking around the next corner.
- Overstated customer base. When you buy a business, you're also buying the business' customer base. If the business' customer base is weak, untenable, or (worst case) non-existent, the deal may need to be called off or at least restructured as an asset sale. Either way, use due diligence to assess the strength of the customer base very early in the sale.