Commercial due diligence: questions before buying a business
Before buying a business, establish why customers buy, how much revenue depends on a few relationships and what supports the growth forecast. Commercial due diligence should turn those questions into an evidence request, a set of checks and a record of the assumptions still open.
Write down the proposed investment case
State what the buyer expects to acquire and why the business is attractive. The reason might concern recurring customer demand, access to a market, a product range or a working distribution network. Put the expected benefit and the conditions needed for it into writing.
Define the questions which could change the decision. These might include the loss of a major customer, an owner-dependent sales process, an expiring distribution arrangement or a forecast requiring more capacity than the business has.
Set the review period, permitted access and responsible advisers. Agree confidentiality arrangements and who is allowed to contact customers or suppliers. Customer interviews require an agreed process so the investigation respects the transaction and existing relationships.
Reconcile the customer and revenue records
Request sales by customer, product or service, month and channel for an appropriate period. Ask how credits, refunds, discounts, tax and cancelled work appear in the export. Give the accountant the relevant records to reconcile reported sales with the financial information.
Look for repeat purchasing, lost customers and changes in order size. A customer list needs dates and transaction history to show activity. Ask which accounts are currently buying, which are inactive and which have commitments covering future work.
Review customer concentration using a clearly defined revenue period. In an illustrative business with annual revenue of 2,000,000 and 600,000 from its largest customer, that customer represents 30 percent of revenue. Record the currency and calculation. Then inspect the relationship, contract and costs associated with that account.
| Question | Evidence to request |
|---|---|
| Who produces the revenue? | Sales by customer, date, service and channel. |
| How durable is the relationship? | Renewals, repeat orders, customer feedback and account history. |
| What supports future revenue? | Contracts, confirmed orders, renewal dates and cancellation provisions. |
| How does the record reconcile? | The source system, financial records and explanations for differences. |
Test the reason customers stay
Ask what customers value and what alternatives they consider. Review complaints, returns, service failures and reasons for lost accounts. Compare the seller's explanation with permitted customer research and the transaction records.
Establish how much of the relationship depends on the departing owner or a particular employee. Ask who manages major accounts, who holds technical knowledge and what transition work is proposed. Record the time and resources needed for an orderly handover.
Review competitors serving the same customer need and area. Record their relevant offers, available alternatives and dates checked. Their published claims need verification before they enter the buyer's forecast as established facts.
Review contracts and the operating constraints
Give the attorney the material customer, supplier, lease and distribution agreements. Ask which arrangements need consent or other action as part of the proposed transaction. Put unresolved contract questions into the decision record.
Check the licences, permissions, premises and operating resources the business relies on with the relevant advisers. The review should identify who holds each permission or agreement and what needs confirmation for the proposed ownership and operating plan.
The legal, accounting and commercial reviews need to exchange findings. A growth assumption involving a larger premises, additional equipment or a new customer contract affects the commercial forecast and the work of the other advisers.
Rebuild the growth forecast from its inputs
Break projected sales into quantities, prices, customer numbers, retention and timing. State where each input comes from. Identify whether it is supported by completed trading, signed work, a customer indication or management's expectation.
Build a base case and clearly described downside cases with the accountant or financial adviser. These could test a delayed contract, a lost major account, lower volume or higher delivery costs. Apply the related cost changes so the result reflects how the business actually operates.
Keep the currency, period and treatment of working capital clear. A profitable sale and the date its cash arrives affect different parts of the plan. Ask what cash the business needs to fulfil the forecast and when the buyer must supply it.
Require a decision record with open questions
The final report should state the question, evidence, finding, uncertainty and consequence for the decision. Attach the request list and record material information which was unavailable. Date each important source and identify who supplied it.
For each unresolved issue, name the person who will obtain the answer and the date needed. State whether the finding changes a forecast input, requires specialist advice or needs attention in the transaction discussions.
Bring the proposed transaction, available records and decision timetable when briefing DSDillon on commercial due diligence. Agree the commercial questions and specialist responsibilities before the investigation begins.
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