You might be surprised to find out that the small and medium-sized business (SMB) acquisition due diligence process analyzes much more than financials. While verifying financials is a top priority and an excellent starting point, finances are just the tip of the iceberg when it comes to need-to-know information about a company you want to buy.

The finances of your target company might look amazing, but other factors in the business can impact your long-term success once you take over. The purpose of due diligence is to uncover whether your target business has the capacity to maintain profitability and even grow under new ownership—which means you have much more to learn about than just finances. Think operations, customers, and industry, just to name a few.

Below are the 8 essential parts of SMB due diligence and what to look out for.

Key Takeaways:

Learn from everyone involved in the business including industry players, customers, employees, and the seller.
Understand the company’s operations, how it makes money, and how it will continue making money into the future.
Use what you learn in the diligence process to start formulating a strategic growth plan and decide on what changes you’ll need to make after close.

1. Financial Status

Sellers are motivated to present their business in the best light. That means you need to double check their numbers. Hire a due diligence expert to prepare a Quality of Earnings (QoE) report to verify the financial documents given to you by the seller. In addition to providing an adjusted EBITDA, this report will include a financial statement analysis and evaluation of each add-back. It also analyzes bank statements to verify cashflow and ensures the consistency of margins as the business grows.

2. Legal Obligations

Develop a list of every contract that the company must abide by including leases, warranties, and compensation agreements. Also, be aware of any pending and potential lawsuits that the business might be involved in. When in doubt, engage a lawyer to review documents with you.

3. Operations

Understand how your target business operates. Are current systems effective? How might you change them when you take over? If you don’t understand why the business is run a certain way, try to find out. Identify major weak points and start devising potential solutions. You should also consider whether current operations will support future growth.

4. Customer Base

Talk to customers to learn about their experience with the business. Find out why they are or are not satisfied with its products or services. This can help you identify areas for improvement and whether certain customers might be close to leaving. It’s also important to know whether one or a small number of customers make up the majority of revenues and how you might be able to mitigate that risk. Finally, ascertain if any loyalty to the existing owner might disrupt business once you take over.

5. Existing Team

Get to know the people who make up the company. Understand their skill levels and whether they are cross-trained. Think about whether key members of the team will stick around after the sale or if they will need to be replaced. Start to consider what an org chart under your leadership might look like. The existing team can also be a great source of information about how the business realistically operates— which might differ from the story you get from the current owner or upper management.

6. Industry Knowledge

If you’re new to the industry, learn everything you can about it. Consider joining an industry association or hiring an industry expert or a broker who recently worked on a deal in the same industry. This will help you understand how much opportunity for growth the industry can actually offer the business. Sometimes, owners are motivated to sell because they expect an industry downturn to occur sometime soon. (Check out this War Story about when this happened to me.) The health of the industry will impact your success, so try to know it inside and out.

7. Seller Relationship

Your relationship with the seller is an excellent way to learn deeper information about the business. That’s one of the reasons you should ensure your relationship stays on good terms. By fostering a comfortable, trusting relationship, the seller will be more likely to be upfront and share detailed information that you couldn’t learn from anyone else. You should also read between the lines and be cognizant of what the seller might not be sharing. When in doubt, get your team to push for more details so your personal relationship remains strong.

8. Growth Potential

To make real money on your deal, you’re going to have to grow the business. Get to know the sales process including major strategies, who is responsible for bringing in revenue, and how new business is acquired. Identify the biggest opportunities for growth, and use the due diligence process to develop a realistic growth plan to implement after you take over.

Now that you know the most important areas to focus on when investigating the business that you want to buy, you might be wondering what are the most important questions to ask.

Check out our resources for the inside scoop!

8 Essential Parts of SMB Acquisition Due Diligence