How does the due diligence process work when buying a business?

Due diligence is the buyer’s structured check of a business before committing to buy it. BDC says it gives crucial information on a target’s finances, prospects and legal issues, and places it as the last of the three key steps before the purchase agreement is negotiated. This guide explains how that process runs: where it starts, who does which part, what each stream looks at, and what happens with the findings. It is the process view. Lists of documents and the cost of the work are covered on other pages.

Where diligence starts and what it is for

BDC says there are two earlier steps, identifying the target company and signing a letter of intent and confidentiality agreement. Diligence then lets the buyer test initial expectations, make sure there are no major red flags and confirm that the initial valuation and letter of intent still make sense. BDC adds that it gives the buyer access to the premises, records and, in some cases, key suppliers, customers and employees. BDC calls the confidentiality agreement essential for the buyer. Agree with the seller early on where you will spend time and what information you need.

Three streams and the people who run them

BDC describes commercial due diligence, financial due diligence (often called accounting due diligence) and legal due diligence. It says an accountant can help analyze the company’s financial records, and a lawyer can assist with the letter of intent, draft the purchase agreement and conduct legal due diligence. It also lists IT specialists to check technology assets and environmental consultants to study contaminants. Draw up a short plan of who reviews what, so nothing is missed or requested twice. Our glossary entry on due diligence gives the short definition.

The commercial review

BDC says commercial due diligence involves understanding how the target makes money, its competitive environment and its future goals and strategy. It asks whether most of the company’s sales come from a small number of customers, whether the business depends heavily on one supplier, and whether customers leave when the vendor does. It also asks who actually runs the business day to day. BDC notes some vendors hesitate about letting you meet customers, suppliers and employees, so raise that early.

The financial review

BDC lists accountant-prepared year-end financial statements for past years, and trends in sales and profit margins. It asks whether the figures match what the owner has told you and whether tax returns match the financial statements. For a closer look, BDC says an accountant can prepare a quality of earnings report, which goes beyond standard statements to identify and adjust for non-recurring items, accounting irregularities and risks. BDC’s own page on financial statements lists the balance sheet, income statement and cash flow statement.

The legal review and registry checks

BDC says legal review covers items such as leases, licences and permits, real estate and intellectual property, employment contracts, and ongoing, pending or threatened litigation. It adds that you should make sure key contracts, such as leases, regulatory agreements and customer contracts, can be assigned to you if necessary. Alberta’s government says to search the personal property registry system before buying any items that are considered personal property; ask your lawyer which registry applies in the seller’s province. Corporations Canada says every federal corporation must file its annual return with Corporations Canada every year, so if the seller is a federal corporation, check that filing is current.

What happens with the findings

BDC lists red flags such as pending litigation and unsigned contracts, and says not to rush. It says the length of the period depends on the complexity of the company and the transaction. Findings go back into the deal: ask your lawyer and accountant whether each one should change the price, the terms or the decision to proceed. BDC says financial due diligence will help you validate the purchase price. It also says to be ready for the same scrutiny from the other side if you ever sell: share your financial statements and other business records, and expect the buyer to ask to meet key employees. That decision stays with you.

• Agree a plan with the seller for access to records, premises and key people.
• Assign the financial review to an accountant and the legal review to a lawyer.
• Check that the financial statements and the tax returns agree.
• Run the registry searches that apply in the seller’s province.
• Write down each finding and what you decide to do about it.