Why is Due Diligence necessary before purchasing a business?

Jun 26, 2023

Reading: 1.5 minutes

You have selected an existing business for purchase and are content with the price. Before proceeding to sign the final purhase agreement, it is useful to request additional documents for conducting a business due diligence. In fact, we strongly advise you to do so. These documents will provide a comprehensive overview of the business's sustainability, highlighting both its strengths and potential risks. This information is vital for making an informed decision regarding the purchase of the business.

Now, let's tackle things step by step:

  • Financial statements. You've already requested them for your business valuation.  They include the company's balance sheet, income statement, and cash flow statement. They also provide insight into the various financial indicators on the profitability of the business. 
  • Contracts: these include any contracts the company has with customers, suppliers, employees, and other parties. These contracts will give you an understanding of the terms of each agreement and help you identify any potential legal risks.
  • Legal documents: these include any lawsuits the company is or has been involved in, any compliance issues and any other legal issues the company may face. These documents will help you determine any potential legal risks you may assume if you purchase the business.
  • Asset Inventory: This document will list all the assets of the business, including inventory, equipment, real estate, and other assets. This information will also either confirm the value of the business or may significantly reduce it.
  • Employee records: These records contain information about the company's employees, such as dates of employment, job titles, qualifications, and job descriptions. This information will help you assess the number of employees at the company and identify possible problems with employees.
  • Customer Records: These records include information about the business' customers, their categories and what products/services of the business they buy, how regularly, etc. This information will help you assess the customer base of the business and identify any potential problems with customers.
  • Reputation and Brand Risks: Researching a company's reputation and brand is critical. Due diligence can identify customer complaints or other issues that may affect the company's image and future success.

In addition to these specific documents, you can also request marketing materials, documents assessing environmental risks and environmental compliance, customer surveys or employee feedback.