Due diligence when buying a business: what to check before you commit

Due diligence is the work you do to confirm that a business is what the seller says it is. It is your chance to find problems while you can still renegotiate the price, add protections to the contract or walk away. This guide covers what to check and who can help. For a printable list, use our due diligence checklist.

When due diligence happens

Some buyers start checking before they make an offer. More often, the buyer and seller sign a contract that is conditional on due diligence, giving the buyer a set period to investigate. Either way, sign a confidentiality agreement first, and keep your questions and the seller's answers in writing.

You do not need to do this alone. An accountant should review the financials and a solicitor should review the lease, contracts and legal searches. Their fees are small compared with the cost of buying the wrong business.

The financials

business.gov.au suggests reviewing several years of financial records, including tax returns, Business Activity Statements, profit and loss statements, balance sheets, cash flow and sales records.

• Check the figures against each other. Turnover in the profit and loss statement should be consistent with the sales reported on the Business Activity Statements and with deposits in the business bank account.
• Look at the trend. One good year can hide a decline. Ask for monthly figures to see seasonality and recent performance.
• Test the add-backs. Sellers often add personal or one-off expenses back to profit. Accept only those the seller can prove, and ask whether the profit figure already allows for a wage for the owner. If the owner works full time and does not draw a wage, you will need to pay a manager or work those hours yourself.
• Understand the costs. Check rent, wages and the cost of goods against turnover, and ask whether any costs are about to rise.
• Debts and commitments. Ask what money is owed by and to the business, and which debts will be paid out at settlement.

The lease and premises

For many businesses, the lease is as valuable as the goodwill. Ask your solicitor to check:

• how long is left on the lease and what options to renew it there are
• how and when the rent is reviewed, and which outgoings the tenant pays
• whether the permitted use covers the business as you plan to run it
• any relocation or demolition clauses
• the tenant's obligations to restore the premises when the lease ends.

Find out early whether the landlord will consent to assigning the lease to you, or whether you will need to negotiate a new one. business.gov.au lists this as a key question for buyers.

Legal and ownership checks

• ASIC and ABN Lookup. Confirm the selling entity exists, who controls it, and that its details match the contract.
• Personal Property Securities Register. A search shows whether anyone has registered a security interest over the business's assets, such as equipment bought on finance. Search against the seller's details (for a company, an organisation search usually uses its ACN), and make sure any interests are released at settlement.
• Licences and permits. Check which licences the business needs, whether they can be transferred to you and how long that takes. The Australian Business Licence and Information Service (ABLIS) on business.gov.au lists licences by industry and location.
• Contracts. Read the agreements with key suppliers and customers. Can they be transferred? Do they end on a change of ownership?
• Disputes. Ask whether the business is involved in any legal disputes, complaints or regulator action.
• Online assets. Confirm that the website, domain name, social media accounts, phone numbers and customer lists are part of the sale and can be handed over.

Staff

Find out who works in the business, what they are paid, which award or agreement covers them and what leave they have accrued. Ask who is likely to stay.

If employees transfer to you, the Fair Work rules on transfer of business decide which of their entitlements and service carry over. In some situations a new employer can choose not to recognise earlier service for things like annual leave and redundancy, and the seller may then need to pay out those entitlements. The contract should say who is responsible for what.

Customers, suppliers and the market

• Customer concentration. If a few customers make up a large share of sales, ask whether they are under contract and whether they are likely to stay with a new owner.
• Supplier terms. Check pricing, minimum orders and any exclusive supply arrangements.
• Competition and location. Visit at different times of day and week. Look for new competitors, roadworks, developments or changes that could affect trade.

Equipment and stock

List the equipment included in the sale, check its age and condition, and confirm what is owned outright and what is leased or financed. Agree in the contract how stock will be counted and valued at settlement, and exclude stock that is damaged, out of date or slow moving.

Warning signs

Slow down if you see any of these:

• the seller cannot or will not produce financial records
• figures that do not reconcile, or takings described as "mostly cash" without records
• pressure to sign quickly or to skip checks
• a lease that is close to ending with no option, or a landlord who has not been approached
• a business that depends heavily on the owner's personal relationships or skills
• staff or key customers you are not allowed to meet before settlement.

None of these automatically means you should walk away, but each one deserves an answer before you commit.