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When buying a small business, it's essential that you know what it is that you're buying. Many small businesses are sold based on seller stated revenue and earnings figures and without delving into the financials to make sure the numbers are substantiated, a buyer can end up overpaying for a business that generates revenue much less than what was stated.

A good starting point for financial due diligence is to request the business tax returns, sales tax returns, employment tax returns, profit and loss statements(if any), and balance sheets (if any) for the past three years. Bank statements are also very helpful because if a business owner tells you how profitable the business is and the bank statements show fees for bounced checks on a regular basis, it's a pretty clear indication that there are some issues to be uncovered.

Do the employment tax returns show sufficient wages for the number of employees that work for the business? If not, is the business owner paying some employees under the table? If so, why? Are the employees undocumented? If so, as a buyer you have to decide if you want to (a) walk away, (b) replace part of the workforce, or (c) risk the penalties associated with hiring undocumented workers and improperly paying payroll taxes and workers compensation insurance. The penalties can be severe so it's worth investigating prior to making a decision.

Another due diligence item that may require investigation is licenses and permits. Is the business licensed properly and does it have all the required licenses and permits to conduct the operations that have been generating the revenue?

You can find detailed due diligence checklists online that can be pared down to be useful without being overkill. Depending on the business, you may need to add items that are specific to the industry. There are consultants, CPAs, attorneys and others that you can hire to assist with due diligence for a fee. Some buyers don't want to spend any money investigating the business up front; however, a few thousand dollars invested on due diligence can uncover problems that may save you hundreds of thousands of dollars in the future. Think of it as being similar to having a property inspection prior to buying real estate. At the end of the day the most important thing for you as a buyer is to know what you are buying.

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LA Business Pros
3500 W. Olive Ave. Ste 300
Burbank, CA 91505
Phone: (818) 781-0082
Toll Free: (888) 853-0986
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Professional Associations

Business Enterprise Institute, Inc. - Exit Planning Solutions

M&A Source

International Business Brokers Association, Inc. (IBBA)

California Association of Business Brokers (CABB)