Due diligence checklist for buying a business
Short answer
A due diligence checklist for buying a business covers nine areas: financial statements and tax returns, bank statements and revenue, add-backs and owner costs, legal and entity records, the lease, employees, customers and contracts, operations and equipment, and licences and permits. Request documents for each area, test them against each other, and turn every problem into a price change, a contract clause or a reason to walk away.
Start with the financial checks. They're the cheapest to run and the most likely to change the deal.
Due diligence is where you find out whether the business you agreed to buy in the LOI is the business you're actually getting. It isn't a box-ticking exercise. Each document on the list exists to answer a question, and the useful part is comparing documents against each other: the P&L against the tax return, the tax return against the bank, the payroll against the staff you met, the lease against what the seller told you.
Print this, share it with your attorney and CPA, and mark who owns each item. The order below is deliberate: financial first, because financial problems change price, and price problems are easier to fix before you've spent money on lawyers.
1. Financial statements and tax returns
- Three years of federal business tax returns, with all schedules (Schedule C, Form 1065 or 1120-S, and the depreciation schedule).
- Monthly P&Ls and balance sheets for the same three years plus year to date, and the same period last year.
- Any CPA-prepared statements (compiled, reviewed or audited) and the accountant's contact.
- Reconciliation of P&L profit to taxable income for each year. See tax returns vs P&L.
- Permission to check returns against IRS transcripts (your lender will do this anyway). See IRS tax transcripts.
- Sales tax returns, payroll tax filings and any notices from tax agencies.
2. Revenue and cash
- Statements for every bank account, merchant processor and payment app, 12 to 36 months.
- Seller's written confirmation that the account list is complete.
- A proof of cash: monthly deposits reconciled to reported revenue.
- Revenue by customer, product line or location, and by month, to see concentration and seasonality.
- Accounts receivable aging and bad debt history (if the business invoices).
- Independent revenue evidence specific to the industry: POS reports, platform dashboards, payer remittances, utility usage. See how to verify revenue.
3. Earnings, add-backs and owner costs
- The seller's add-back schedule, with a document behind every line.
- Owner compensation: W-2s, distributions, benefits, perks, and who else in the family is paid.
- Three years of repairs, legal and professional fees, to test "one-time" claims.
- Related-party transactions: rent paid to the owner, purchases from relatives' companies, loans to or from the owner.
- Capital spending history and the equipment list, to judge deferred maintenance.
- Your own rebuilt SDE with each add-back rated. Try the SDE calculator.
4. Working capital and the balance sheet
- What's included in the sale: inventory, receivables, prepaid expenses, deposits.
- Normal levels of inventory, receivables and payables month by month, to set a working capital peg if there is one.
- Customer deposits, prepaid memberships and gift cards you'll have to honor.
- All debt, equipment leases and liens, and confirmation they're paid off or assumed by agreement.
5. Legal and entity
- Formation documents, operating agreement or bylaws, ownership records, good standing certificate.
- UCC, tax lien and judgment searches on the entity and owners. See UCC lien searches.
- Pending or threatened lawsuits, demand letters, regulatory complaints, settlements in the past few years.
- Material contracts: customers, suppliers, franchise agreement, software, equipment leases. Check assignment and change-of-control clauses.
- Intellectual property: trademarks, domain names, social accounts, software and who owns them.
- Insurance policies and claims history.
- Environmental reports where relevant (gas stations, dry cleaners, auto repair, manufacturing).
6. The lease or real estate
- The lease and every amendment, with remaining term and renewal options.
- Assignment clause and the landlord's consent process, plus any personal guarantee required. See lease assignment.
- Rent escalations, CAM charges, who pays utilities and repairs.
- Landlord estoppel letter confirming no defaults.
- Zoning and permitted use, if anything about the use is unusual.
7. Employees
- Employee census: roles, pay, hours, start dates, benefits, accrued paid time off.
- Contractor list and how they're used. Misclassification is a liability; see the IRS guidance linked below.
- Key people the business depends on, and whether they'll stay.
- Employment agreements, non-competes, handbooks, any claims or complaints.
- Payroll tax filings and proof they're current.
8. Customers, suppliers and operations
- Top customers by revenue for three years, with tenure and contract terms. See customer concentration.
- Calls with a few key customers and suppliers, arranged with the seller near the end of diligence.
- Supplier terms, pricing history and any exclusivity.
- Equipment and vehicle list with age, condition and maintenance records.
- Systems: POS, accounting, scheduling, CRM, and who has the passwords.
- Online reviews and reputation over time.
9. Licences and permits
- Every business, professional, health, liquor, contractor or environmental licence, with the holder's name.
- Which transfer, which you must apply for fresh, and how long that takes. See transferring business licenses.
- Recent inspection reports and any violations.
How to run diligence without drowning
- Send one organized request list on day one, grouped like the sections above, and ask for a shared folder.
- Keep an issues log: issue, evidence, size in dollars, proposed fix (price, clause, walk).
- Do the financial checks yourself first. If earnings don't hold up, stop before the expensive legal work.
- Meet the people last, once the seller is ready to tell employees and you're close to closing.
- Feed every issue into the purchase agreement: specific representations, indemnities, a holdback, or a price change.
For the written questions to send, use due diligence questions.
The due diligence process for buying a business
Due diligence usually runs in phases after a signed letter of intent: first confirm the earnings are real (proof of cash, tax returns, add-backs), then check the things that could kill the deal (customers, lease, licences, key staff), then the legal and operational detail while the lender underwrites and the purchase agreement is drafted. Do the cheapest, most decisive checks first, so that if something is wrong you find out before spending on lawyers and appraisals.
Diligence isn't one big checklist done all at once. It's a sequence, and the order matters: check the things that would end the deal first, cheaply, before spending money on the rest.
The phases
Phase 1: are the earnings real?
- Proof of cash: bank deposits vs reported revenue.
- Tax returns vs P&L, and transcripts.
- Each add-back with its evidence.
- Trailing twelve months and trend.
Phase 2: deal-killers
- Customer concentration and contract terms.
- Lease assignment and term.
- Licences that may not transfer.
- Key employees and the owner's role.
Phase 3: detail and the lender
Legal review, liens, contracts, employees, equipment and inventory, while the lender orders its own valuation and any required reports, and attorneys draft the purchase agreement.
Phase 4: closing
Final inventory count, working capital, lien payoffs, transfers and funds. See the closing process.
Who does what
| Who | Typical role |
|---|---|
| You | Leads, talks to the seller, checks operations |
| Accountant | Financial and tax review; QoE where needed |
| Attorney | Legal review, purchase agreement, closing |
| Lender | Underwriting, valuation, required reports |
| Specialists | Environmental, equipment, industry |
How long does due diligence take when buying a business?
For a typical lender-financed small business purchase, due diligence and financing usually run over weeks to a few months after the LOI is signed, and the LOI's exclusivity period should allow for that. The biggest delays come from slow or incomplete seller records, lender underwriting and third-party reports, landlord consent, licence approvals and franchisor approval. Agree a document list and timeline in the LOI, and track what's outstanding every week.
Diligence takes as long as its slowest dependency. Usually that's not you: it's the seller's records, the lender, or a third party who has to approve something.
What slows it down
| Cause | How to reduce it |
|---|---|
| Seller records late or incomplete | Full request list in the LOI; weekly follow-up |
| Lender underwriting and valuation | Engage the lender before the LOI |
| Landlord consent | Start as soon as the seller agrees |
| Licence or franchisor approval | Learn the process and timing first |
| Findings that need renegotiation | Check deal-killers first |
A weekly tracker
- Documents requested, received, reviewed.
- Open questions to the seller.
- Lender status and next requirement.
- Third-party approvals and dates.
- Exclusivity end date.
How much does due diligence cost when buying a business?
Due diligence costs depend on deal size, structure, industry and how good the seller's records are. The usual line items are legal fees (diligence and the purchase agreement), accounting or a Quality of Earnings review, lender fees and lender-ordered reports (valuation, sometimes environmental or equipment appraisals), specialist inspections, and searches. Some are hourly, some fixed-fee, and some required by the lender. Get written quotes for each before you sign the LOI, and spend in the order that tests the deal-killers first.
The cost of diligence is real money you may not get back if the deal falls through. Spend it in the right order.
The line items
| Item | Usually priced | What drives it |
|---|---|---|
| Attorney: diligence and purchase agreement | Hourly or flat fee | Complexity, structure, negotiation |
| Accountant / QoE review | Fixed fee or hourly | Deal size, record quality, scope |
| Lender fees and packaging | Set by the lender and SBA rules | Loan size |
| Business valuation (lender-ordered) | Fixed fee | Size, complexity |
| Real estate appraisal, environmental | Fixed fee | Property, history |
| Equipment appraisal or inspection | Fixed fee | Amount of equipment |
| Lien, judgment and entity searches | Per search | States and names |
| Industry specialist | Hourly | Scope |
How to keep it under control
- Get written quotes and scopes before signing the LOI.
- Run proof of cash and add-back checks first.
- Ask the lender which reports they'll require and when.
- Agree with your attorney when to start drafting.
Frequently asked questions
What documents do I need for due diligence when buying a business?
At minimum: three years of business tax returns, monthly P&Ls and balance sheets, 12 to 36 months of bank and merchant statements, payroll records, the lease, major contracts, an equipment list, licences and permits, and entity and lien records. The checklist on this page lists them by area.
How long does due diligence take?
For a small business it commonly takes several weeks to a few months, depending on how organized the seller is and whether an SBA lender is involved. Write a realistic diligence period into the LOI.
Can I do due diligence myself?
You can and should do a lot of it yourself, especially the financial checks and talking to the business's people. Legal review of contracts, liens and the purchase agreement needs an attorney, and tax structure needs a CPA.
What if the seller won't provide something on the list?
Ask why, in writing. Some items genuinely don't exist in very small businesses. But refusing tax returns, bank statements or the lease is a serious warning sign, and an SBA lender will need most of them anyway.
When does due diligence start?
Formal diligence usually starts after a signed LOI with an exclusivity period, though you should review the basic financials before making the offer.
Who does due diligence?
The buyer leads, often with an accountant (financial and tax), an attorney (legal and the purchase agreement), the lender (its own underwriting and required third-party reports) and industry advisors as needed.
Sources
- SBA: Buy an existing business or franchise
- SBA SOP 50 10 8.1, Appendix 15: lender documentation and financial due diligence
- IRS: Get Transcript
- IRS: Independent contractor (self-employed) or employee?
Related guides
General information, not legal, tax, financial or investment advice. Rules and lender practices change; check the linked sources and talk to your attorney, CPA and lender about your deal. Examples with named numbers are illustrations, not real businesses. OKtoBuy does not value businesses or give price opinions.