Detailed Due Diligence Hacks You Need to be Doing
Due diligence is a critical step in assessing whether you should purchase an asset or not. Digital due diligence generally focuses on details like backlinks, website speed, traffic analysis, SEO, and so on. A lot of these broad due diligence items are well covered in the 10 Step Due Diligence Guide, but this article focuses on some extra ones that you may not have considered. We’ll go onto a granular level so you can really make sure you know what you’re buying and that it checks out.
Before we dig in, it’s important to note that due diligence finds out the good points and the bad points of a business, but the bad points don’t necessarily mean that the business isn’t worth buying. Sometimes those bad points are, in fact, opportunities for you to grab hold of and make improvements in that area. So, treat due diligence like you’re a detective trying to solve a case. Look into every detail, ask questions, and compile all of this information into an overview for you to then assess and decide whether to proceed with the purchase or not.
Right, let’s get into it. We’ve broken these detailed due diligence items into groups, with a description to help you navigate them easier.
The Business Owner
So much due diligence focuses on the website and business itself. However, a lot can be done to check the validity of the business based on the owner and their background.
Look into the background of the owner by searching on Google for the business/brand name and looking at social media, trade publications, etc. You want to ensure they’re legitimate and there isn’t any bad press about them, the brand, or the business. Examples of where to look could be Facebook personal profiles, company directories, the Securities and Exchange Commission, Trustpilot, and just a general Google search of their name.
Discuss with the owner why they are selling the business. You really want to get into detail with them on this point to ensure that their reasoning is sound and that there isn’t something they’re not telling you about the business.
I’ve heard the typical statement “I just want to focus on my new venture” from business owners many times. Normally, there is more to it than this. Whenever I’ve dug deeper, I’ve found out things that made me walk away from the sale, so this is one area I focus on.
Make time to do a questions and answers session with the owner. Ask them questions like how many hours a week they work, how many holidays they take per year, and what’s the best and worst things about the business from their point of view. You want to understand as much about their business routine as possible to see if this will suit the way you want to work.
Contracts and Agreements
Ideally, any third parties related to the business need to be brought over with the sale so you can continue to benefit from their services. To this end, contracts are key to have in place, as well as agreements that they will continue to work with you, the new owner.
If it’s a business-to-business model, are there key customers who return over and over and make up the majority of the sales? If so, are there sales contracts in place, and have you confirmed that they are happy to continue with a new owner?
If the business uses freelancers for content, SEO, customer service, etc., then check them out in terms of their experience and availability going forward. They should be contracted to the business, which is automatic if you hired them via platforms like Upwork, but you should verify that they will agree to continue working with you if you buy the business.
SOPs and Specifications
Has the business owner set up standard operating procedures (SOPs) for any third parties the business works with? These should outline what the third party is to do for the business and what the expected results should be in terms of quality, delivery timeframes, pricing, etc.
If the business relies on manufactured products and/or supply of inventory, then there should be written specifications in place for how the product is made, packaged, and delivered. You should check that the suppliers are happy to continue working with you. Also, investigate the availability of alternative suppliers, should you need to change over for any reason.
If the inventory is manufactured, does it rely on custom moulds or templates? Does the business or the manufacturer own these? If you need to change manufacturers in the future, this could influence your ability to do that.
Does the business have all the necessary permits and licenses (importing, customs, etc.) for any products it sells? Ensure that they are all current and not out of date.
Much of the financial assessment will be part of the general due diligence prepared by the business broker. We’ve added some important things to consider in addressing these financials.
Have an independent party, like your accountant or bookkeeper, review all the provided financial documents. They will likely bring up a different set of issues than you, which you can then address with the owner.
Review the revenue per product. This involves breaking down the income into individual products to see which ones are the most profitable. This may reveal some products that aren’t profitable. But don’t see this as a negative immediately—you may be able to reprice these products or even drop them from the range.
Assess the time lag from the point of sale to when the money turns up in the business’ account. This is likely to be more relevant for business-to-business companies because most ecommerce business-to-consumer arrangements see the money in their account immediately. What are the payment terms of the customers? What you’re checking for is whether you’ll have enough cash surpluses to cover this period.
Compile a detailed cost breakdown of the products in terms of supply, freight, storage, advertising, expenses, sale prices, and profit. You want to look for potential pain points in the costing structure that could be an issue going forward. An example of this could be shipping; if the cost of shipping were to greatly increase, then how does this affect the products’ profitability and therefore the business’ overall profitability?
Make an assessment of the current inventory. Is it popular selling stock or is there “deadwood” in there? You don’t want to pay good money for inventory that you won’t be able to sell, so compare the current inventory with the best-selling products list and ensure that there are no large amounts of low-selling stock in the current inventory.
For example, in a business I considered buying, the main product made up 80% of the sales and the remaining four products were poor sellers, but the company was holding a lot of these in stock. The owner wanted to sell this stock to me for the price he bought it for. As you can imagine, I passed on buying this business.
Marketing and Potential
While you want to go all detective style on due diligence, you also need to be assessing opportunities for growth within the business.
Prepare a detailed SWOT (strengths, weaknesses, opportunities, and threats) for the business, making lists under each of the headings. This will provide an overview of the good and bad points and the opportunities to grow. This should be an internal document to help form your overall decision to proceed with the purchase or not. So, for example, if you list plenty of critical weaknesses and threats but very few opportunities, then maybe this isn’t the business for you.
What marketing materials does the business currently have? Look for tools to use in ongoing marketing, like imagery, videos, etc. What social media accounts are set up, and how have these been used to market the business? Does the business have a branding set up, like color boards, logos, and font selections? These are important because if these are in place and they’re used across all media and marketing schemes, then the business shows a consistent brand that customers will already recognize.
Check to see if the business has a customer relationship management (CRM) system in place. These CRMs are a central location for storing all communications between the business and its customers; these are an important asset to a new owner to help them get quickly up to speed with what communications have happened and what follow-ups are needed. This is mainly important for business-to-business models, not business-to-consumer models.
Does the business have an email list? Check how this is managed: have the emails been collected legally, and are they stored in a software platform like Mailchimp for ease of use?
After the Sale
There’s so much that happens up to the sale of a business that the time after this is often not a point of focus. The handover period is actually one of the most important times for a new business owner, and the following points will help you better prepare for this period.
Discuss with the business owner how they propose to do the handover, especially in terms of immediate training. Get a commitment from them for a certain number of days immediately following handover, when they can guide you through the standard operating procedures of the business.
Check out the ongoing support period and consider having the business owner agree to an extended period of time than what is normally proposed. Most of the time, this is 3 months, so see if they will agree to 6 or 12 months because it’s hard to get fully up to speed on a new business in only 3 months. Personally, I have never been able to get up to speed on a new business in less than 6 months, and normally, I am not comfortable until a full 12 months has passed. Being able to talk to the former owner 12 months later has helped me greatly, so consider this point in your negotiations.
If it’s a product-based business, address the topic of warranty claims with the owner during due diligence. Query the amount of warranty claims they have each year, and come to an agreement on how warranty claims from products sold by the previous owner will be dealt with when you own the business.
Wrapping It All Up
The points covered in this article touch on some important areas of focus when you’re assessing a business in due diligence. There are other factors that are relevant to individual business models and niches, so seek the advice of a lawyer, broker, accountant or other to ensure you cover all the points in making a good assessment of the opportunity. You can use this handy checklist when starting your due diligence.
The whole point of detailed due diligence is to enable you to get a thorough understanding of what the business is, how it operates, what its pros and cons are, if it’s suited to you and your lifestyle, etc. No business is perfect, and when conducting due diligence, you will find some “warts” and things you don’t like. The important thing is to ask these two questions:
- Is this item a big enough issue for me not to buy the business?
- Can I turn this item into an opportunity rather than a problem?
Making an assessment of the issues is important. Finding those non-negotiables is key to due diligence and ensures that you don’t buy a lemon.
Be realistic. If you perform detailed due diligence correctly and are true to your values, you may have to go through this process for a number of businesses before finding one that fits your brief.
The best way to prepare yourself for this process is to list out your values, lifestyle, and non-negotiables, and use this as a sounding board when assessing each business because this will help when making the overall decision to buy or not to buy.
Detailed due diligence is really just detailed information gathering, and it’s your own sounding board that drives the final decision to proceed or not proceed with a purchase.
Treat every due diligence opportunity as an educational experience because you will learn and become better at it each time, and ultimately, this will put you in a better position to find the right business for you. Good luck!