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If you’re on the hunt for the perfect business to buy, you may have come across several interesting options. However, you need a method to narrow down your choices to a handful of serious candidates. This is where preliminary due diligence comes into play—it’s the process of investigating and evaluating these businesses to help you determine if they warrant further consideration.

The objective of preliminary due diligence is to gather enough information about a business to assess its suitability for purchase. Unlike formal due diligence, which occurs just before finalizing the purchase, preliminary due diligence takes place during the search and discovery phase when you’re gauging whether the business aligns with your buying criteria.

Essential Elements of Preliminary Due Diligence

Asking the Right Questions

Qualifying a business involves asking pertinent questions to obtain the necessary answers. Consider the following:

  • Is this an established business, or is it a digital asset sale?
  • Does it fall within the appropriate range in terms of revenue, earnings, and purchase price?
  • Can you run it from your current location, or would relocation be necessary?
  • Do you possess the skills to manage the business effectively?
  • Does the business align with your desired lifestyle?
  • Do the earnings of the business provide a satisfactory income?
  • What is the reason behind the owner’s decision to sell?

Examining the Business

When purchasing an online business, the entire process can be conducted over the internet. However, you may want to meet the business broker or owner in person, and if the business involves physical goods or inventory, a visit to the premises might be necessary. It’s possible that you’ll have to repeat this process multiple times. Don’t be discouraged if you meet with several brokers and sellers before finding the right opportunity. This can actually work to your advantage as you gain firsthand exposure to different types of businesses. Through this process, you’ll learn more about your preferences and identify what appeals to you and what doesn’t.

Assessing Suitability

Before delving into the nitty-gritty of a business’s financials, it’s crucial to ensure that it aligns with your interests and goals. In most cases, you’ll be considering businesses that require your active involvement to streamline operations and generate profits. If the business niche or industry doesn’t appeal to you, it’s less likely that you’ll be committed to making necessary improvements. However, it’s important to note that lack of knowledge or passion should not automatically rule out a business. For example, you may come across a lifestyle blog that initially seems uninteresting, but with your skills and expertise, you realize its potential for growing revenue. Ultimately, evaluate where you fit into the business. If you can’t envision yourself being genuinely interested or skilled in a way that enhances the business, it’s best to move on to the next opportunity.

Emphasizing Financials

As part of your preliminary due diligence, inquire about the availability of the following financial statements and request to review them:

  • Profit and loss (income) statement
  • Cash flow statement
  • Balance sheet
  • SDE (Seller’s Discretionary Earnings) statement

When examining these documents, keep in mind that many small businesses employ strategies to minimize taxes, which might result in showing a loss for tax purposes.

However, when tax optimization is removed, these businesses can still be actually profitable and support the owner and their family. It may require some detective work to uncover the true financial situation.

Evaluating Business Potential

Don’t be quick to dismiss a business that appears to be underperforming. Upon closer inspection, you may discover untapped potential for improvement. While the purchase price is typically based on past performance rather than potential revenues, it’s acceptable to give weight to the potential for making a difference in the business after the purchase.

When considering buying a business, a portion of your decision should be based on its past performance, while another portion should focus on the improvements you can bring to the table.

Considering an Offer

Once you believe a business meets your buying criteria, it’s time to take a more serious approach and decide whether you want to make an offer. This stage requires a closer evaluation of the business’s value and whether the owner’s asking price is fair. It’s advisable to seek professional assistance at this point and hire someone experienced to guide you through the purchase process.

Key Takeaways

By conducting thorough preliminary due diligence, you can effectively assess potential businesses and narrow down your options to those that align with your goals and criteria. Remember to ask the right questions, examine the business closely, evaluate its suitability for your interests and skills, analyze the financials, and consider the potential for improvement. With each step, you’ll gain valuable insights that will ultimately guide you toward making an informed decision when purchasing a business.

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