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How a Simple Due Diligence Checklist Helps You Buy the Right Profitable Business

Vincent Wong July 1, 2020

How a Simple Due Diligence Checklist Helps You Buy the Right Profitable Business

Remember the last time you went window shopping with an intention to buy something but left empty handed because you were just overwhelmed by too many options?

It’s exciting to buy an online business, but browsing through what’s available on the marketplace can cause even more confusion.

You can narrow down your choices with the filter on our marketplace to show a tailored selection of available businesses.

However, if your only prerequisite to acquire a business is whether it’s within your budget, you won’t get very far.

For any M&A transaction, a buyer always needs to first consider the risk and opportunity.

Buyers often make a big mistake in looking at businesses from a perspective of growth opportunity first.

This is where due diligence comes into play.

People often recommend going through a due diligence checklist before agreeing to any deal.

But what is due diligence and how does it separate the wheat from the chaff?

What is Due Diligence?

Due diligence is a thorough appraisal process to check the financial and operational health of a business.

It’s different from a vetting process, which determines if a business is priced correctly.

While some businesses leave due diligence for their legal team or lawyer to handle, it’s advisable for most investors to establish a rigid due diligence framework when looking to acquire an online business.

It might sound obvious, but people don’t like to show the negative sides of a business. A due diligence checklist saves you time by focusing on businesses that pass your risk tests.

To Get Ahead, Start Working Backwards

Lots of businesses have potential, but you want to choose the ones with the least risk.

An effective due diligence framework disqualifies a business as quickly as possible if it doesn’t pass your risk criteria.

To find out whether a business meets your goals and is the best fit for you, you’ll want to turn over as many rocks as possible as you check for a number of risk factors.

You’ll protect yourself from unforeseen circumstances resulting from a lack of information during initial conversations with the seller. There’s no worse feeling than discovering a glaring issue only after you’re the owner of the business. And by then, it’s too late to back out.

Good due diligence makes sure you get it right the first time.

Online businesses are unique in that they have different assets and therefore different considerations compared to a brick and mortar business.

Treat the checklist as a pass/fail test at each section. Continue measuring the business using these criteria until it doesn’t meet the requirements or passes them all.

The checklist below isn’t exhaustive but serves as a basis for you to start your own due diligence.

Due Diligence Checklist Before You Acquire a Business

Business Model

People use established online business models to build their brand.

While these models provide a framework for creating an online business, you’ll want to confirm that all the essential elements that make these models successful are in place. It’s hard to build on a brand if its foundation isn’t solid; its basic features have to be established.

Look out for signs of authenticity and that the products or services offered are legitimate.

  • For e-commerce businesses, check that the storefront is legitimate. If it’s an Amazon FBA business, does the store have listings related to its niche?
  • For content sites, check which affiliate programs are used and that their commission rates reflect what’s advertised.

Content

“Content is king” has been the mantra for some time. What people mean by this is quality content will cut through the noise and is more likely to be acknowledged by search engines.

When auditing content, you’re mainly checking for quality and originality.

Profitable businesses that leverage content marketing focus on creating high-quality content for its users.

After spending some time reading and understanding the content, see if it provides value to the target audience.

Watch out for plagiarism on Google by cross-checking text. Duplicate text that pops up verbatim in a quick search is a clear sign of poor quality content.

  • Has the business been hit with any warnings or had content taken down due to plagiarism?
  • Is content tailored to the user rather than a search engine?
  • Is the content over-optimized for keywords?

Backlink Profile

It used to be easy to rank a content site many years ago: the number of backlinks pointing to your site directly correlated with your site’s rank.

Now, search engines are much savvier, and they’re concerned with the quality of these linking sites.

Pay careful attention to the anchor text. Do these links lead to high-authority sites with useful information that’s relevant to the article that the link came from?

Links leading to pages with commercial intent indicate Private Blog Networks (PBNs) are being used.

While some view the use of PBNs as a black hat SEO method, many more consider them a grey hat method.

You can use tools like Ahrefs to check the backlinks profile of a site to understand whether the backlinks generated from PBNs violate any agreements.

  • How high is the domain ranking or store ranking, if the business is e-commerce?
  • Are the backlinks from varied sources?
  • Are the backlinks related to the niche and helpful?

Traffic

One advantage an online business has over a brick and mortar store is the ability to monitor how many people pass through a site, as well as provide insight into their behaviors.

If an online business has analytics software installed, review the traffic data. E-commerce businesses also have their own traffic analytics.

You can see how much time visitors spend on the site on average and how many pages they check out before leaving the site.

If traffic shows a steady positive trend, this indicates that the brand may be growing in authority as more people come across it.

A decrease in traffic could be due to several reasons, such as Google algorithm changes, a lack of fresh content being produced, or the niche’s popularity dying down.

Depending on your goals, a downward trend for traffic might be suitable if you want to grow the business.

  • Is there an even spread of traffic across the pages?
  • Has there been a spike in growth rate?
  • Is the majority of traffic from organic search, paid advertising, direct searches, or referrals?
  • How long do visitors spend on the site?
  • Where is traffic coming from?
  • What’s the best-case scenario for organic growth?

User Experience

You wouldn’t spend long on a site that’s jarring to use and gives you a headache to look at.
A site’s design plays a big role in how visitors interact with it. It’s difficult to quantify, but the general notion surrounding user experience is ease of use.

Does the site take long to load between pages? Are there many broken or expired links that interrupt your browsing experience? Poor technical SEO prevents search engines from crawling through it efficiently.

There are tools to show where you need to implement 301/302 redirects and repair broken links, such as Screaming Frog.

Put yourself in the customer’s shoes as you browse the site. If you’re left with no complaints, this is a good sign that you don’t have much work to do to optimize it.

  • Is the site easy to navigate?
  • Does clicking on links lead you to the intended destination?
  • Is there a brand logo?

Competition

Many interpret a competitive niche as a sign of profitability.

You’ll need to do some competitor analysis to understand the type of competition the business is up against, and whether the business will survive or be able to thrive.

  • If there is a lot of competition, identify the competitors and determine if you’ll be able to stand out.
  • It’s equally important to note if there aren’t a lot of competitors and understand the reason behind this. Is it because the niche isn’t in demand?

Niche

Choosing a niche doesn’t inherently determine the success of an online business. It’s more to do with your skillset and if you have an interest in it.

However, you should pay attention to the longevity of your niche and find out if it is trendy or evergreen.

If you go to Google Trends, a simple indicator of an evergreen niche is if there’s steady growth or a plateau in interest in the past five years.

A trendy niche will be declining as interest wanes.

Trendy niches are only popular for a short while (think Pokémon Go), which means the business may not be profitable in the near future.

  • Has the niche been on an upward or downward trend over the past few years?
  • Are you interested in this topic?

Revenue

This is a difficult criterion to establish because it depends on your goal.

If you’re looking for a business to build, decreasing monthly net profit over time might be tolerable.

However, if you’re looking for a business in a profitable niche and that is experiencing steady growth, it will have a healthy stream of revenue.

As part of your financial due diligence checklist, consider asking for the past three years’ financial data so you can see a clearer picture of the business’s financial health.

We have a strict vetting procedure to ensure that quality listings appear on our marketplace. We require content sites to make at least $500 per month in net profit and all other businesses to make $1,000 per month over a 12-month period.

Consider hiring a professional to check the profit and loss (P&L) statement if you don’t have experience reading the financials.

  • Does the seller have a P&L statement?
  • Do the costs of goods sold and revenue tally?
  • Does the business make enough to cover the expenses?
  • How much of the expenses are necessary to maintain the business?

Corporate Structure and General Matters

Good documentation plays a large role in helping a business run efficiently. A lack of important documents, such as written standard operating procedures (SOPs), means the business is reliant on the knowledge and expertise of certain individuals.

While you’re not looking to replace employees, you want to be able to hire someone to take on certain roles as long as they have experience and knowledge of doing certain tasks. SOPs allow you to effectively train competent staff in a short span of time.

It’s also important to have clear plans that indicate where the business is headed and what contingency plans are in place if the business doesn’t meet certain goals.

  • Does the business have clear SOPs that explain how to run the business, as well as explain the coordination protocols between departments (e.g., from sales to marketing)?
  • Has the seller prepared a productivity model for the business’s sales force? This can include details of plans for new hires, how to analyze the sales cycle, laying out the organization hierarchy, and explaining the terms of productivity.

Strategic Fit

If you’re purchasing the business to synergize it with the rest of your organization, ask yourself whether the business is the right fit for your portfolio.

On the other hand, if you’re acquiring the business as a solo project, you’ll need to ask yourself if you’re actually interested in it and have the motivation to make it grow.

It’s difficult to stay enthusiastic about an online business if you wake up every morning with the only aim to stay afloat.

Make sure this is a strategic purchase regardless of whether it’s part of a portfolio or replacing your normal 9–5 job.

  • Does the business synergize with your other ventures?
  • Do you have the skill set to scale the business and, if not, how easy is it to learn or outsource to people who can manage it?
  • Will it be something you’re proud of in 2–3 years or will you be bored before then?

Product and Services

In the same vein as strategic fit, consider the products or services on offer.

Think about whether the product is in a niche that will be in demand in the foreseeable future or if the speed and nature of change in the industry will render it obsolete.

  • How many products are on offer?
  • How many products are still in development?
  • How many complaints about the products/services were made?
  • How many warranty claims have there been?

Marketing

An effective marketing strategy expands a business’s reach to new customers.

You’ll want to review the seller’s marketing strategy: does it effectively move customers along the buyer’s journey?

A lack of diversification in outreach could be an opportunity for growth.

  • Does the business rely on paid advertising or organic traffic?
  • Are there social media accounts and is the company dependent on them for traffic?
  • Does the business have an email list?

Technology

Even if the business model sounds good and the monthly net profit is lucrative, a high-level understanding of knowledge or expertise to run the business can be a high barrier to entry.

When you speak with the seller, ask about how much technical expertise is required to run the site. If depth of knowledge is necessary, check if a software engineer is associated with the company to manage the product or site.

Contracts

Understanding the formal agreements that a company has with different organizations and individuals gives you an idea of what you need to run the company.

Different types of contacts to bear in mind include

  • Contractors or freelancers
  • Supply and service agreements
  • Non-compete
  • Trademarks or patents
  • Employee contracts

Employees

To understand how much effort is required to maintain the business, you’ll need to find out if there are any employees.

Furthermore, it’s important to have a good relationship with the workforce if you do acquire the business. If many of the employees don’t want to continue working with you after the sale, you’ll need to understand their roles and responsibilities in order to replace them.

  • Who are the employees?
  • Do they know the business is being sold?
  • Who’s staying with the business post-sale and why?
  • What are the roles and responsibilities?
  • Where are they situated?

Material Assets

An e-commerce business needs a way to order inventory, store it, and fulfill customer orders.

Inventory management obligations will vary depending on the business model; dropshipping will naturally have minimal inventory issues since orders are fulfilled by the vendor, while Amazon FBA needs a bit more work.

You may want to hire a third-party logistics (3PL) provider if the seller handles most of the logistics themselves or if the process is convoluted. However, a lack of clear procedures regarding order fulfillment is a cause for concern.

  • Where is the inventory stored?
  • How are customer orders fulfilled?
  • Is there any leased equipment?

Legal, Licenses, and Permits

Avoid being caught by surprise from any issues related to legal rights and following legislation.

You may be taxed heavily and, at worst, your business operations could be shut down if the company is found to violate any laws related to intellectual property, taxes, or otherwise.

As part of your due diligence checklist, check if an online business has previously been in any litigation cases or been penalized for breaching terms and conditions.

  • Federal, state, and local licenses
  • Foreign/domestic copyright
  • Trademarks
  • Taxes (including federal, local, state obligations, tax returns, and excise tax filings). For e-commerce businesses, bear in mind VAT obligations when buying an EU/UK business.
  • Insurance coverage: What are the previous insurance claims in the past three years?
  • Litigation: Are there any pending or threatened litigations?

*These are just some factors to consider when reviewing a business, but please take note that this does not constitute legal advice—consult a legal professional regarding tax matters before acquiring an online business to make sure you’re fully aware of how to stay compliant with relevant tax laws.

Speak with the Seller

Last but not least, speaking with the seller can reveal whether the business is a good opportunity.

You’re aiming to nurture a relationship with the seller rather than treat it as an arbitrary task to complete to acquire the business.

Through your interaction with them, you’ll understand the operations and get a better feeling of if a sweetheart deal is being put forward.

  • What is the seller’s pricing philosophy?
  • Does the seller have sole proprietorship of the business?

Passed All Checks? Time to Look Forward

Once the online business has passed all your risk checks, you can consider growth opportunities in different avenues for traffic or revenue.

This could be improving lead generation or building another traffic source through social media. An e-commerce business might benefit from adding new products to its current range or using paid advertising to increase its reach.

It might take some time to construct your M&A due diligence checklist, but you’ll reap the rewards as you save time and money by identifying which businesses pass the risk threshold.

You can save even more time by using our services. We provide most of the information listed above to make it much quicker for you to conduct your own due diligence.

The process of due diligence can take anywhere from 30 to 90 days for brick and mortar businesses.

However, for online businesses, it often takes as little as a week or two to gather this information.

Due to the fast-paced M&A environment of online businesses, we recommend having a plan to move fast. It can get incredibly competitive as the due diligence process is made simpler after sellers submit their businesses for valuation.

If you’d like to get a benchmark figure, try using our valuation tool to see how much you’d pay.

If you like what you see, register on our marketplace so you can unlock listings to start your own due diligence.

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