Due Diligence When Buying a Business: How It Actually Runs

Due diligence is the period, set in your letter of intent, when you verify that the business is what the seller says it is. If you are financing the purchase with an SBA loan, your lender is doing much of the same work at the same time, and the two go fastest when they run together.

Our free due diligence checklist lists the documents to request, with the ones a lender asks for too marked. This guide is about how the process runs.

Day one: send the document request

The diligence clock starts when the letter of intent is signed, and the most common delay is waiting on the seller for documents. Send the full request on day one rather than in batches, and agree how documents will be shared. Ask the seller's broker or accountant to own the request on their side.

Start the loan the same week. The business tax returns, financial statements and lease you need for diligence are the same documents the lender underwrites from.

The financial review

Reconcile the financial statements to the tax returns for each year, then check both against the bank statements. Revenue that appears in the books but not in the deposits needs an explanation.

Go through the add-back schedule line by line, with the document behind each one. Look at monthly results for the last two to three years, not just the annual totals, so you can see seasonality and whether the months before the sale were slower.

Look at who the customers are and how concentrated the revenue is, and at what the business owes: payables, payroll taxes, any debt that has to be paid off at closing.

The legal and operational review

Your attorney reviews the lease, the material contracts, licenses and permits, any litigation, and whether contracts and the lease can be assigned to you. In a stock purchase you take on the company's history and liabilities, so this review goes deeper (stock or asset purchase).

On the operational side, meet the key employees if the seller allows it, understand who holds the important customer and supplier relationships, and look at the condition of the equipment.

What the lender runs alongside

For an SBA acquisition, the lender orders its own reports, and they run on their own schedules: an independent business valuation in most cases (the valuation rule), a quality of earnings report when the business purchase price is $3 million or more (the QoE rule), and an appraisal and environmental review if real estate is part of the deal. Order them early. They are often what sets the closing date.

When diligence finds something

Most findings are negotiated rather than fatal: a price reduction, a larger seller note, a specific representation in the purchase agreement, or a working capital adjustment at closing. One tool common outside SBA lending is not available: earnouts paid to the seller based on future performance are prohibited in an SBA change of ownership, though rebates from the seller to the buyer and working capital true-ups are allowed (the earnout rule).

Whatever you find, decide before the diligence period ends. Exclusivity usually ends with it.