Buying a business: a legal due diligence checklist

Buying a business is exciting, and that excitement is exactly where buyers get into trouble. Due diligence is the careful investigation you do before you commit, so you know what you are buying and what you are taking on. This guide is a practical checklist.

Why due diligence matters

When you buy a business, you may be buying its problems as well as its profits. Due diligence is how you find the problems before they become yours. It also gives you leverage. What you find can justify a lower price, a special condition, a warranty, or walking away.

The pattern we see most often is a buyer who falls in love with the business and treats due diligence as a formality. It is not a formality. It is the cheapest insurance you will buy in the whole transaction, and the findings often pay for the whole cost of the advice several times over.

Asset sale or share sale

First, understand what you are actually buying. In an asset sale, you buy the business assets, such as the equipment, stock, goodwill, and contracts, but not the company itself. In a share sale, you buy the company that owns the business, which means you also inherit its history and its liabilities.

This distinction drives the whole due diligence exercise. A share sale needs far deeper investigation, because you take on everything the company has ever done, including tax and legal liabilities you may not see. There is a separate article in this series comparing asset sales and share sales.

The due diligence checklist

The areas we work through on a business purchase include the following.

• Structure and ownership. Who owns the business, what entity runs it, and that the seller can actually sell what they are offering.
• Financials. The accounts, tax returns, and the real state of the business, checked with your accountant.
• Contracts. Key customer and supplier contracts, and whether they can be transferred to you or will end on a change of ownership.
• Lease. If the business operates from leased premises, the lease terms, the remaining term, options, and whether the landlord will consent to an assignment or grant a new lease.
• Employees. Entitlements such as leave and long service leave, employment contracts, and which staff will transfer.
• Intellectual property. That the business owns its name, brand, domain names, and any IP it relies on.
• Licences and permits. Any licences, registrations, or permits the business needs to operate, and whether they transfer.
• Litigation and disputes. Any current or threatened claims.
• Liabilities. Debts, guarantees, and any contingent liabilities, especially in a share sale.

The areas that most often cause problems

If we had to name the areas that most often spring a surprise, they are the lease, the employees, and the transferability of key contracts.

The lease matters because many small businesses live or die by their location, and a lease that cannot be assigned, or has little term left, can undo the whole deal. Employees matter because accrued entitlements are real liabilities that have to be accounted for in the price. And key contracts matter because a customer contract that ends on a change of control can mean you are buying less than you think.

The sale agreement

Due diligence feeds directly into the sale agreement. What you find should be reflected in the price, the conditions, the warranties the seller gives, and any retention or adjustment. A well-drafted agreement allocates the risks you found and protects you if something was not disclosed.

Get the legal and the accounting advice working together, and get it before you sign anything, including any heads of agreement. Early non-binding documents can shape the deal in ways that are hard to undo later.

Frequently asked questions

What is due diligence? The investigation a buyer carries out before committing, to understand the business, its risks, and its real value.

How long does due diligence take? It depends on the size and complexity of the business, from a couple of weeks for a simple asset sale to much longer for a share sale of a larger company.

Do I need due diligence for a small business? Yes. Even a small business can carry a problem lease, unpaid entitlements, or a contract that will not transfer.

What is the difference between an asset sale and a share sale? In an asset sale you buy the assets, not the company. In a share sale you buy the company and inherit its liabilities. The share sale needs deeper due diligence.

Keep reading

• Business sales and acquisitions
• Asset sale vs share sale: which is better?
• What to check before signing a commercial lease

This article contains general information only and is not legal advice. For advice about your situation, please contact us. Liability limited by a scheme approved under Professional Standards Legislation.