What is Due Diligence?
The Short Answer
Due Diligence explained simply
Due diligence is like checking under the hood of a car before you buy it. It’s the period where a buyer gets to dig into all aspects of a business. This includes looking at financial records, legal documents, customer contracts, employee agreements, and operational procedures. The goal is to confirm that what the seller has presented is true and that there are no hidden problems or surprises. It’s a critical step to make sure the buyer knows exactly what they are getting into.
Real-World Example
The Coffee Shop Due Diligence
Imagine you’re buying a coffee shop. During due diligence, you’d ask for:
- Financial Records: Three years of tax returns, profit and loss statements, and balance sheets. You’d check if the reported revenue matches the bank deposits.
- Lease Agreement: You’d review the lease to ensure the rent is stable and there are no clauses that could force you out.
- Employee Contracts: You’d look at employee agreements to understand salaries, benefits, and any potential liabilities.
- Supplier Contracts: You’d check agreements with coffee bean suppliers to ensure pricing and terms are favorable.
If the seller claimed $10,000 in monthly profit, you’d verify this by looking at their bank statements and expense reports. If the numbers don’t add up, you might renegotiate the price or walk away.
Why this matters
Due diligence protects the buyer. It helps you uncover potential risks, liabilities, or misrepresentations before you commit to buying a business. It gives you the information you need to make an informed decision, negotiate a fair price, or even decide not to proceed with the purchase if the risks are too high.
Never skip due diligence. It’s your chance to verify everything. If a seller pushes back on providing documents, that’s a red flag. Be thorough and ask for everything you need to feel comfortable with the purchase.
Never skip due diligence. It’s your chance to verify everything. If a seller pushes back on providing documents, that’s a red flag. Be thorough and ask for everything you need to feel comfortable with the purchase.
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