Buying an existing business can be a faster path to scale than building from scratch. You inherit customers, cash flow and a team on day one. The catch is that you also inherit every problem the seller would rather you did not see.
Due diligence is how you find those problems before you sign, not after. It is the work of verifying that the business is what the seller says it is and that the price reflects reality. Done well, it either gives you confidence to proceed or hands you the evidence to renegotiate or walk away.
This guide breaks diligence into five workstreams and finishes with a checklist you can take into your next deal.
Financial Due Diligence
Start with the numbers, because everything else is downstream of them. Ask for at least three years of financial statements, income tax returns and Business Activity Statements (BAS), then cross-check them against each other. Reported revenue should reconcile to the BAS lodgements and to the bank statements.
Scrutinise the add-backs. Sellers normalise earnings by adding back owner salaries, personal expenses and one-off costs to inflate the profit figure you are buying on. Some add-backs are legitimate; many are optimistic. Test each one and rebuild the maintainable earnings yourself.
Look hard at working capital. Understand the cash tied up in stock, debtors and creditors, then agree how working capital will be handled at completion so you are not left funding the business from your first day. A registered tax agent or accountant should verify the financials before you rely on them.
Legal Due Diligence
Confirm exactly what you are buying and from whom. Verify the selling entity through ASIC, check that the people signing have authority and confirm whether key assets sit inside the entity or are personally owned by the seller.
Work through the contracts. Read the premises lease in full, including the remaining term, options to renew, rent reviews and whether the landlord must consent to any transfer or change of control. Review supplier and customer contracts for assignment clauses, because some agreements end the moment ownership changes.
Confirm that all licences, permits and registrations needed to operate are current and transferable. Search for current or threatened litigation. Confirm who owns the intellectual property, including the business name, trade marks, domain names and any software. Search the Personal Property Securities Register (PPSR) to check whether plant, equipment or stock carries a security interest for someone else’s debt, which can cost you the asset even if you bought in good faith.
Commercial Due Diligence
A profitable business can still be fragile. Map customer concentration first. If one or two clients drive most of the revenue, the business is far riskier than the headline profit suggests. You should understand how those relationships are likely to behave after the founder leaves.
Examine supplier terms with the same care. Test whether pricing, credit terms or exclusivity depend on the current owner’s relationships and whether any single supplier could disrupt you. Then look outward at the market: demand trends, competitors and anything (regulation, technology or a major customer’s own plans) that could erode the position you are paying for.
Operational Due Diligence
Understand how the business actually runs. Document the systems, software and processes, then confirm whether they are owned, licensed or held together by one person’s knowledge.
Key-person risk is the issue that most often surprises buyers. If the owner is the main salesperson, the technical expert and the relationship holder, much of the value may walk out the door at settlement. Review the team, employment terms, accrued leave and entitlements and any reliance on a small number of staff. Plan early for how knowledge and relationships will transfer to you.
The Deal Itself
How you structure the purchase has significant tax and risk consequences. In an asset purchase you buy selected assets (goodwill, equipment, stock and contracts) and generally leave historical liabilities behind. In a share purchase you buy the company itself, which means you take on its history, including unknown debts, tax exposures and past claims. These two paths carry different tax outcomes for both sides, so model them with a registered tax agent before you commit.
Consider GST. The sale of a business may be GST-free as the supply of a going concern where the conditions are met, broadly that the sale is for payment, the buyer is registered or required to be registered for GST, the seller carries on the enterprise until completion and both parties agree in writing that the sale is of a going concern. Get this confirmed in advice and documented in the contract.
Consider stamp duty (transfer duty). Whether duty applies to business assets such as goodwill, intellectual property and plant depends on the state or territory and on what you are buying; several jurisdictions have abolished duty on many non-land business assets while others still charge it. Confirm the current position for your jurisdiction with your adviser, because the rules and rates change.
Finally, negotiate the protections. A reasonable restraint of trade stops the seller from competing against you or poaching staff and customers. A defined transition period keeps the seller available to hand over relationships and know-how. Warranties and indemnities give you recourse if the business is not as represented.
Your Due-Diligence Checklist
- Three years of financial statements, tax returns and BAS, reconciled to bank statements
- Add-backs tested and maintainable earnings rebuilt
- Working capital understood and a completion adjustment agreed
- Selling entity verified through ASIC and signing authority confirmed
- Lease reviewed in full, including term, options and consent to transfer
- Customer, supplier and key contracts checked for assignment and change-of-control clauses
- Licences, permits and registrations confirmed current and transferable
- Litigation searches completed and IP ownership confirmed
- PPSR searched for security interests over assets
- Customer and supplier concentration mapped
- Systems, processes and key-person risk documented
- Staff entitlements, leave and employment terms reviewed
- Asset versus share structure modelled with tax advice
- GST going-concern treatment confirmed and documented
- Stamp duty position confirmed for the relevant jurisdiction
- Restraint of trade, transition plan, warranties and indemnities negotiated
Where Foothold Advisory Fits
Diligence is where deals are won or lost, yet most SME buyers run it without a clear framework or enough support. Foothold Advisory can help you scope the diligence, pressure-test the financials and the deal structure, then brief the right specialists at the right time.
Book a consultation or a structure and tax review with Foothold Advisory before you sign. A few focused hours of preparation can save you from a costly mistake and put you in a far stronger position to negotiate.
General information only. This article provides general information about Australian business structuring and tax concepts and is current as at its publication date. It is not legal, tax or financial advice. Foothold Advisory is not a registered tax agent and is not a law firm. Structuring, succession and acquisition decisions have legal and tax consequences that depend on your circumstances and timing. Before acting, obtain advice from a lawyer and a registered tax agent.