How Smart Business Buyers Create a Due Diligence Checklist

What is a Due Diligence Checklist?

A due diligence checklist gives you a comprehensive list of documents you’ll want to obtain and review for any company acquisition. Once you have your documentation in hand, you can analyze it and begin to ask questions, challenging the story you have about the business’s revenue, net income, operations, and overall success.

What are Due Diligence Documents? 

Due diligence documents disclose information about the business, so buyers can understand its operations and the income opportunity. The range of document types you’ll seek will depend on the type of company you’re vetting, but typically include these types: 

• monthly and annual profit-and-loss statement 
• legal contract 
• balance sheet 
• financial statement 
• income statement 
• customer list
• company operations and orientation manuals
• projections, surveys, or forecasting data

Due diligence documents are used by buyers as a way to learn about and analyze a prospective company acquisition.

Why is a Due Diligence Checklist Important? 

Smart sellers want to scrutinize every scrap of information they can get about a prospective business acquisition during their due diligence process. A due diligence M&A checklist helps ensure you don’t overlook any documents that could shed light on the value of a business you might buy. Using a detailed checklist helps avoid any unpleasant surprises post-sale.

There are a number of documents and facts you’ll want to gather from the business owner or their management team for your due diligence. Your checklist helps jog your memory about everything you need, so you get all the information at your fingertips.

How to Make A Due Diligence Checklist

Due diligence checklists generally have a basic format with items covering each aspect of operations–you can grab a useful due diligence checklist sample here, and a document request form here. But don’t consider any due diligence M&A checklist template you find online to be complete. 

Always plan to customize your due diligence checklist for buying a business with any industry-specific items that need to be reviewed. Once you’ve gathered all your documents and data, you can ask the questions that enable an informed decision about whether this business is a good investment.

What to Do After Compiling Your Due Diligence Checklist

Whether your target business is being acquired through a sale or a merger, your acquisition due diligence checklist guides you through the process. You’ll find out what this business offers, both good and bad: assets and liabilities, income and expenses, operations details, and more. 

Your due diligence checklist should help you answer all those fundamental questions, but don’t forget issues specific to the industry your acquisition operates in. You’ll need different types of documentation to vet a SaaS business than you will for a yard-maintenance company. The checklist should be custom-tailored to the type of business you’re acquiring and the type of transaction, whether acquisition, asset sale, or merger.  

Questions You Should Ask During Due Diligence

Let’s review some fundamental due-diligence questions acquirers should ask in any small- to middle-market transaction. No business sale will have all of these issues, but you want to ask as many questions as you can. Remember, sellers are motivated to portray their business in the most positive possible light. If you don’t ask specific questions that could reveal a less pretty picture, the seller often won’t volunteer negative information.

Here are our top questions to ask in each basic category of due diligence:

Business Cash Flows

• Type: How does this business make money–ad clicks, physical product purchases, service fees, a licensing model? Do customers make one-time purchases, or is there regular, recurring revenue? Are there multiple revenue sources?
• Forecast trends: Has revenue grown or shrunk in recent years? Does recent income or bookings indicate revenue is scaling up, stagnant, or declining?
• Pricing: How do prices compare to competitors’? Is there opportunity to raise prices?
• Owner relationships: To what extent will the removal of the current owner impact revenue? 

Business Expenses

• Costs: Reviewing the list of costs, does it appear some expenses be cut?
• Trends: Have expenses grown or shrunk in the past 5 years? 
• Unusual expenses: Are there upcoming one-time costs that have been deferred, employee loans outstanding, or other costs you would inherit?

Business Assets

• Does the business own property? If so, does equity exist in the asset, or is it mortgaged to the hilt?

• Is there documentation for any equipment or machinery owned or leased?
• Are there copyrights, patents obtained or applied for, trademarks? If so, could an independent industry expert estimate their value? 
• Are there trade secrets or team knowhow that has value? If so, how is it protected?

Business Liabilities

• What outstanding debts does this business have–and which will be paid prior to sale, which become your responsibility post-sale? Examples could include accounts payable, refunds due, overdue taxes, vendor payments, or loan payments.
• Are there any debts where a loan might be called or payment terms changed if company is sold? 
• Have any related parties such as co-owners, relatives, or investors loaned money to the company?
• Have any business or seller’s personal assets been listed as collateral for any debts?
• Any unrecorded liabilities? Ask the seller or employees to find any debts that have been kept off the books.

Financial Information About the Business

The financial information available from your seller may vary widely. A small mom-and-pop shop will have less robust financial documentation than a publicly traded company. A few key questions:

• What are gross margins? 
• What are this company’s fixed and variable expenses? Could any be reduced or cut?
• What is the company’s credit rating, if it has one?
• What revenue is anticipated? Any overdue or unpaid accounts that might impact profit?
• If there’s physical inventory, how much money is tied up in inventory? Could inventory be optimized to improve cash flow?
• Do sales or gross profits vary by geography, channel, or product type?
• Have sales varied substantially from what was projected?
• Has the company issued private stock, options or warrants? What are the obligations there?

Business Operations 

Once you understand what money is coming in and out of the business, and what resources it has and the debts it faces, it’s time to learn how the puzzle pieces fit together. How does this business work?  Some questions to ask here:

• How is the company organized, in terms of business form? Is there an organizational chart?
• Is the business properly licensed to operate everywhere it does business?
• What products or services does it sell, and what’s in development? What information is available about the offerings–surveys, tests, evaluations?
• If there are physical products, what does the supply chain look like?
• What types of marketing are used, and how efficient are they?
• Who are the largest few customers and how much of total sales do they represent?
• Who are the top vendors or suppliers and what agreements does the business have with them?
• Who operates the business – what’s the size of staff and/or contractors needed?
• If there are staffers, what benefits are they offered? Any union contracts?
• Is there a disaster recovery plan?

Technical Due Diligence

• Does this business have intellectual property, patents, team expertise? What is the value of these assets?
• What technology is used in this business? What are its costs? Do all the software pieces work together well, or are there problems? 

Industry Information

• Is this industry generally thriving, or in decline? 
• What’s the speed and nature of change within the industry?

Back Office Issues

It’s a low-glamour area, but some of the administrative functions in a business can hold ticking time bombs you’ll want to find, as a prospective buyer. A few top areas to ask about:

Insurance Due Diligence

• Is there adequate healthcare, liability, employee, key man, or other insurance coverage? 
• What’s the claims history?

Legal Due Diligence

• Is there any pending or threatened litigation, injunctions, or settlements against the business or any of its officers? 
• Any history of problems with regulatory bodies such as the SEC or IRS?
• Are there legal agreements for all important relationships – employee contracts, contractor agreements, franchise contracts, vendor or distributor memos, sales agreements?

Tax Due Diligence

• What federal, state, local, excise, and foreign taxes does this business pay annually? How has that changed in the past 3 years?
• Are there any tax liens against the business for nonpayment?
• Has the company collected and remitted employment tax due?
• What accounting principles does this business operate on?

Environmental Due Diligence

• Are there any EPA notices, environmental audits, or environmental liabilities such as hazardous materials used?
• Is there an approved plan for disposal of hazardous materials?
• Are there anticipated costs for environmental compliance or resolution of outstanding problems? 

Due Diligence Template Examples

As you can see, there’s a lot to consider when you’re buying a business. Start with our free due diligence checklist template and build your own customized acquisition due diligence checklist. 

I hope our due diligence checklist sample helps you thoroughly vet business opportunities and make the right purchase at the right price.