Business Acquisition Due Diligence Checklist

Your Diligence And The Lender's Diligence

Most buyers do due diligence after the letter of intent is signed, during an exclusivity period of 30 to 60 days. You, your CPA and your attorney dig into the business. At the same time, the SBA lender runs its own financial due diligence as part of underwriting.

The two overlap, but they are not the same. The lender's job is to make sure the loan gets repaid. Your job is to make sure you are buying a good business at a fair price. A lender approval tells you the cash flow supports the debt. It does not tell you that a key customer is about to leave, that the lease cannot be assigned or that the equipment needs replacing next year. Those are yours to find.

What The SBA Lender Orders And Checks

SBA makes financial due diligence part of the core underwriting on every business purchase. Expect your lender to handle these:

• An independent business valuation. Prepared by an accredited appraiser for the lender, not for you or the seller. The lender may do its own valuation when the business purchase price is $350,000 or less.
• A Quality of Earnings report, when the business purchase price, not counting real estate, is $3,000,000 or more. See our Quality of Earnings guide.
• IRS tax transcripts. The lender checks the seller's financial statements and tax returns against transcripts from the IRS, and checks the valuation's numbers against them too.
• A site visit to the business you are buying, documented in the loan file. For e-commerce and other businesses without a customer-facing location, the lender can verify operations in other ways.
• A real estate appraisal, if the building is part of the deal, plus an environmental review where it applies.
• Liens on everything you buy, including transferable licenses, and proof of insurance. The credit memo also addresses life insurance on the owners.

The out-of-pocket cost of the valuation and QoE can be passed on to you, financed in the loan, and anything you pay toward them counts toward your Down Payment.

Financial Checklist

Start with the numbers, because everything else depends on them.

• Three years of business tax returns and year-end financial statements
• Year-to-date interim financials and the same period from last year
• Monthly bank statements for at least the last 12 to 24 months, tied to reported revenue
• A list of every add-back the seller claims, with receipts or payroll records behind each one
• Accounts receivable and accounts payable agings
• A schedule of all business debt, leases and liens
• Payroll reports and payroll tax filings
• Sales tax returns, if the business collects sales tax
• Inventory count and how it is valued
• Capital spending over the last three years, and what is due soon

The most important test is whether the earnings in the listing show up in the tax returns and bank deposits. Lenders underwrite from the tax returns, not the broker's summary. Our guide to SDE and add-backs covers which add-backs lenders accept.

Legal Checklist

Work through these with your attorney. This article is general information, not legal or tax advice.

• Entity documents, ownership records and good standing in each state
• The lease: remaining term, renewal options, rent increases and whether the landlord must consent to assignment
• Key contracts with customers and suppliers, and any change of control or assignment clauses
• Licenses and permits, and whether they transfer to a new owner
• Lien, judgment and litigation searches on the business and the seller
• Intellectual property, domain names and software licenses
• Insurance policies and the claims history
• Franchise agreement and the franchisor's transfer approval, if it is a franchise
• Any government notices, citations or open audits

The lease deserves special attention. Lenders typically want the lease term, including renewal options, to run at least as long as the loan, and a landlord who drags their feet on consent can delay closing by weeks.

Customers And Revenue

Find out how durable the revenue is:

• Concentration. What share of revenue comes from the top customer and the top ten? If one customer is a quarter of sales, talk to the seller about how that relationship will transfer.
• Contracts. Are customers on contracts, purchase orders or nothing at all? When do contracts renew?
• Recurring revenue. How much repeats every month or year, and how many customers leave each year?
• Pricing. When were prices last raised, and how did customers react?
• Pipeline and backlog, for project-based businesses.

Employees And Operations

A business is mostly its people and its processes. Ask for:

1. An organization chart, with tenure and pay for each role.
2. The names of employees who hold key customer relationships or licenses, and whether they plan to stay.
3. How many workers are employees and how many are contractors.
4. A list of equipment and vehicles with age, condition and maintenance records.
5. Key suppliers, terms and any single points of failure.
6. Exactly what the seller does each week, so you know what you are replacing.

Under SBA rules the seller cannot stay as an owner or employee, but can consult for up to 24 months. Plan the handover with that in mind. See seller transition and consulting.

What To Do With What You Find

Due diligence often turns up something. Here is how one finding can change a deal:

In this case the gap is small. The buyer can ask for a lower price, ask the seller to move part of the price into a note on full standby, or bring more cash. When the gap is large, or the finding is about honesty rather than numbers, walking away is often the right call. Our guides to negotiating price and terms and why acquisitions fall apart cover both paths.

Fitting It Into Your Timeline

Most SBA acquisitions close 60 to 90 days after the LOI. Front-load the financial review, because the lender's valuation and QoE depend on the same documents. Our LOI to closing timeline shows how the pieces fit together week by week.

Before you start, a pre-qualification letter confirms the deal can be financed, so your diligence budget goes toward a business you can actually buy. See the SBA business acquisition loan page for how the loan works.