What is Due Diligence in a Business Sale?

by Vanessa Lovie 31st of August, 2022

What is Due Diligence in a Business Sale?

Due diligence is the process where the buyer gets to review the business sale in full detail to ensure it meets their expectations.

You may find when scrolling through business sales on Bsale that very little information has been provided by the seller. This is to encourage the buyer to make contact and receive more information that is not publicly available.

The first step when looking to buy an opportunity is to contact the seller. They will often ask you to complete an NDA so confidential information can be protected. The seller may then provide you with more information such as a business memorandum, but it still won't be the full picture.

Why? Because business sales lean on the side of caution, there is a need for secrecy for the current owners and the future buyer. If the information falls into the wrong hands it could have a detrimental effect on the business sale and future operations of the organisation. So sellers prefer to keep the information confidential to an extent.

This is why there is a process of due diligence in a business sale. It’s a bit like a building inspection report in real estate, but a lot more in-depth and detailed. After all, buying a business is more complex than real estate.

When Can you Perform Due Diligence in a Business Sale?

Due diligence is typically performed after a “term sheet” has been created and agreed to by both parties. A term sheet basically outlines the expectations of each party during the due diligence process in a business sale.

In some instances, the Contract of Sale may be finalised with the condition that due diligence has to be successfully completed before settlement. A deposit may also be required, which is held in a Trust Account by the seller's business broker or solicitor. If the conditions aren’t met then the buyer may have the deposit returned - if written in the term sheet or contract.

This is to provide the seller with some level of protection, that you are genuinely interested in buying the opportunity. Whilst simple due diligence may commence sooner, you can start researching once you have found a business sale advertised that suits your needs. It is typically conducted after the term sheet is agreed to and a deposit is made.

Providing confidential information to anyone who may be interested is not advised. This is why it's encouraged by professionals to be done after an NDA, Term Sheet and Deposit have been processed. The buyer is then entering the negotiation phase and a Heads of Agreement (HOA) is used to negotiate the terms of the sale with the seller.

What Does Due Diligence Involve?

The process of due diligence allows you to asses a business sale from multiple angles, we take a look at three main angles that are considered

1. Financial

In order for an organisation to be successful, it needs to have its finances in order. The advertised price of a business sale is often determined by its profitability.

A common way is looking at the net profit to the owner and multiplying it by a certain factor, such as 1.5x or 3x, depending on its stability. This is an extremely simplified version. You will find when speaking to a professional, such as a business broker, they will have a different method for determining an appraisal or valuation of a business. Nevertheless, it is usually centred around the financials. This is because the business sale is all about what money the buyer can make.

Here is a list of financial documents that can be reviewed during the due diligence process. Typically, a buyer will want to review a minimum of 3 years, this may vary depending on the type and size of the business sale.

Balance Sheet
Profit and Loss
BAS and PAYG
Tax Debts
EOFY Tax Summaries
Depreciation Schedule
Loans and Liabilities

2. Operational

This section is all about how the organisation operates. As a buyer, you want to have a solid understanding of how the business for sale goes from sourcing products to providing a service and everything in between. To understand the true value of a business sale and to make sure it is legitimate you will need to check and review all of these items. You don’t want to buy a business and find out 3 months later the lease is ending or you didn't check if the ABN is valid!

In this section of due diligence, the buyer will review items such as;

Lease agreements
Licenses and registrations
ABN, ACN, GST
Employment agreements
Supplier lists
Distributor lists
Client lists
Training Systems
Ownership Structure
Franchise agreements (if applicable)

3. Assets

What does the business for sale actually own? Whilst the advertised price of a business sale is often centred around financials and how much money the organisation actually makes, assets also play a part. Depending on the type of business sale there could be thousands (or millions) of dollars tied up in the assets.

In this section of due diligence the buyer can review the following assets:

Equipment
- Machinery
- Vehicles
- Office Equipment
- Computers and Software
Furniture and Fittings
Stock lists (organisations with a lot of stock, such as supermarkets for sale, will often have an advertised price as +SAV and set value, that may be pre-determined or set via a stock take at the time of the sale)
IP, Copyrights, Trademarks
Websites and eCommerce stores
Property and Land Titles (If the business sale is advertised as freehold it may include a land title and dwelling)

Due Diligence in a Business Sale
Image: Who can assist you with the due diligence of a business sale?

Sign up to Newsletter

Weekly updates on business sales and advice, delivered to your inbox.

Who Can Assist You in Due Diligence?

It is also a good idea to obtain professional advice when performing due diligence in a business sale. There is a lot of factors and information to review and you don't want to make the mistake of missing something, and paying for it after the sale has been finalised.

There are 4 types of professionals who can assist you. They all have specific areas of expertise and can help guide you in certain areas.

1. Solicitor

A commercial solicitor can help to review any legal documents such as commercial lease agreements, IP, Trademarks and Copyrights, equipment leases, employment agreements and more. They are also vital during the settlement period and reviewing the contract in the business sale to ensure it is written to benefit you, as it is prepared by the sellers' solicitor and may have unfair terms or items excluded.

2. Business Brokers

They are professionals in buying and selling a business. Anything you need to know about the process, they can assist with. Many business brokers are former owners or accountants and are educated to assist you in reviewing an opportunity. They can also help you determine if the asking price of the business sale is fair, or if there is room for negotiations. They could help save you thousands of dollars, by pointing out inconsistencies or negotiating on the price.

3. Accountant

You will probably have your own accountant, what is important is making sure they understand the process of business sales. Reviewing all the information, and finding gaps or inconsistencies is important. They will help you figure out if the business for sale is profitable as the seller claims, and what your future projections may be. They will also help review the tax liabilities and any debts. They can also assist with your personal tax, and assessing capital gains if you have recently sold another business or property.

4. Business Coach

If you plan to buy a business for sale and grow it, you should have a coach review your plans. It's a good idea to speak with a coach in your specific industry such as a hospitality coach if you are buying a cafe for sale. A coach can help you decide if this is a good business to buy or if it has issues such as equipment that's aging or low foot traffic or ideas to ramp up the marketing and increase sales.

Due diligence is an important part of the buying process of a business sale. You need to ensure you understand exactly what you are committing to. It’s easy to just say yes, and commit to buying a business. But it’s the investigations and research into the claims the seller is making that take time and will give you a level of certainty in your purchase.

If you need assistance in your due diligence process of a business sale, please contact us and we can connect you with some business brokers, accountants or solicitors who have experience in this area.