Why verification matters

Buying a business transfers more than revenue streams — you inherit liabilities, contracts, employee obligations, and often unseen risks. A systematic verification process (due diligence) reduces surprises, informs valuation, and gives you leverage during negotiation. The U.S. Small Business Administration recommends careful review when buying an existing company to understand liabilities, licenses, and financial strength (SBA: https://www.sba.gov/business-guide/plan-your-business/buying-existing-business).

This article gives a practical, professional checklist you can use or share with your accountant and attorney. It includes what to request, common red flags, a realistic timeline, and next steps after issues are found. This is educational information and not personalized legal or tax advice; consult licensed professionals for your transaction.

What documents and data should you request first?

Start by asking the seller for a clear, organized data room. If the seller doesn’t cooperate early, treat that as a red flag.

  • Financial statements: income statements, balance sheets, and cash flow statements for the last 3–5 fiscal years, plus interim financials for the current period.
  • Federal and state tax returns for the last 3 years (confirm with schedules and supporting workpapers).
  • Accounts receivable and payable aging reports, and major customer lists showing revenue concentration.
  • Bank statements for the last 12–24 months.
  • General ledger and chart of accounts (or a summarized export from the accounting system).
  • Fixed asset register and depreciation schedules.
  • Copies of current contracts: leases, major vendor agreements, customer contracts, loans, and equipment leases.
  • Corporate records: articles of incorporation, bylaws or operating agreement, meeting minutes, stockholder ledgers, and UCC filings.
  • Employment records: employee roster, payroll summaries, key employee agreements, non-compete/non-solicit clauses, and benefit plan documents.
  • Licenses and permits required to operate in the jurisdiction(s).
  • Insurance policies and claims history.
  • Any environmental reports (for property-backed businesses) and title documents when real estate is involved.
  • Intellectual property documentation: registrations, assignments, and material licenses.
  • Litigation history and pending claims, including attorney invoices and settlement documents.
  • Seller’s disclosure statement and explanation of any accounting adjustments (e.g., owner compensation addbacks).

Why these items? Tax returns corroborate financial statements and can reveal unpaid tax liabilities (see IRS small business resources: https://www.irs.gov/businesses/small-businesses-self-employed). Contracts show recurring revenue sources and change-of-control consequences.

Practical checklist: step-by-step

1) Preliminary screening (days to 2 weeks)

  • Verify the seller’s identity and ownership. Perform background checks on principals.
  • Ask for a high-level financial package and recent tax returns.
  • Confirm there are no obvious licensing or regulatory impediments.

2) Financial due diligence (2–6+ weeks)

  • Reconcile tax returns to financial statements and the general ledger.
  • Analyze revenue trends, gross margins, and unusual fluctuations in expenses.
  • Review cash flow and working capital cycle; compute normalized EBITDA and note discretionary owner expenses.
  • Request explanations for related-party transactions, large one-time items, and any unusual accounting policies.
  • Run ratios and compare to industry benchmarks; if you don’t have them, see our primer on industry metrics and benchmarking.

3) Legal and compliance review (concurrent with financials)

  • Search for litigation, liens, UCC filings, and judgments. Order a UCC search in states where the seller does business.
  • Review lease assignments and landlord consents for location-based businesses.
  • Confirm permits and professional licenses are transferable or that staff meet credential requirements.

4) Contract and customer review

  • Identify top 10 customers and compute revenue concentration. Heavy concentration (e.g., >20–30% from one customer) is a risk.
  • Check change-of-control clauses, auto-renewals, and termination provisions.

5) People and operations

  • Check key-person dependence and succession plans.
  • Review wage and benefit liabilities, payroll tax filings, and any worker-classification risks.

6) Tax and contingent liabilities

  • Confirm sales and payroll tax compliance; unpaid taxes can become buyer liabilities depending on deal structure.
  • Ask for correspondence with tax authorities and pending audits.

7) Environmental, title, and property (if applicable)

  • For businesses with real property or environmental exposure (manufacturing, auto shops, restaurants), order environmental site assessments (Phase I) and title searches.

8) Intellectual property and data security

  • Verify ownership or valid licenses for trademarks, patents, software, and customer lists. Check for third-party code or open-source license issues in software businesses.
  • Review privacy policies and data-breach history; examine security controls if the business collects personal data.

9) Valuation and deal structure considerations

  • Decide early whether you are buying assets or stock — this affects tax treatment and liability exposure.
  • Use normalized EBITDA, discounted cash flow (DCF), and comparable transactions as cross-checks.
  • Consider holdback, escrow, or indemnity provisions for seller representations. An earnout can bridge valuation gaps but requires measurable metrics and clear dispute resolution.

10) Closing readiness

  • Ensure all required consents, landlord approvals, and regulatory transfers are documented.
  • Have a detailed closing checklist and a post-closing integration plan.

Red flags that should pause or change the deal

  • Seller refuses to provide tax returns, bank statements, or a clean general ledger.
  • Large, unexplained related-party transactions or unusual accounting policies.
  • High customer concentration without written contracts or transition plans.
  • Persistent losses masked by one-time owner-related inflows (e.g., owner loans or infusion).
  • Pending litigation or regulatory investigations not disclosed in writing.
  • Unrecorded liabilities: payroll tax arrears, unpaid vendor claims, or environmental cleanup obligations.
  • Major lawsuits or claims against key owners or managers.

If you find one of these, escalate to your CPA and counsel. Common remedies include price reduction, escrowed indemnity, seller reps and warranties insurance (RWI), or walk-away.

Timing: how long will verification take?

Expect three to twelve weeks for a focused verification of a small-to-midsize business. Complex deals (multi-site operations, regulated industries, international exposure, or significant IP issues) often take several months. Begin with a 2–4 week focused review to surface deal-breaking items; then extend as needed for deeper investigation.

Cost considerations

Budget for professional fees: an M&A attorney and CPA are essential. Expect an accountant’s detailed review to cost several thousand dollars for a small business; larger or more complex transactions can run tens of thousands. Additional specialist costs (environmental consultants, patent attorneys, cybersecurity auditors) should be budgeted based on industry risk.

Examples from practice

  • Case: a small bakery that looked profitable. Adjusting for owner salary addbacks and a pending lease escalation reduced the normalized EBITDA by 40%, changing the buyer’s offer and negotiation strategy.
  • Case: a service firm where lawsuit risk was not disclosed. Discovery of litigation led to an escrow holdback and a lower purchase price.

These examples show how verification changes price, structure, and the buyer’s appetite for risk.

Negotiation levers when you discover issues

  • Price reduction or purchase price holdback into escrow.
  • Seller-funded escrow to cover future indemnity claims.
  • Representations & warranties insurance to shift catastrophic risk off the parties.
  • Staggered payments or earnouts tied to measurable performance metrics.

Work with counsel to draft precise language — vague protections are often unenforceable.

After verification: integration and monitoring

A good integration plan reduces value leakage post-close. Prioritize: 1) customer retention (communicate with key customers quickly), 2) employee retention (preserve institutional knowledge with clear offers and expectations), and 3) systems migration (accounting, payroll, and contracts).

Track actual results against pro forma projections for at least 12 months; consider a closing-to-earnout reconciliation and an escrow claims calendar.

Helpful resources and further reading

For deeper process guidance, see FinHelp’s related glossary pages on Due Diligence and Buying an Existing Business: Financing Options and Due Diligence.

Common questions

  • How much does verification really reduce risk? It doesn’t eliminate it, but careful diligence materially reduces unknowns and provides contractual remedies for discovered liabilities.

  • Can a buyer insist on seller-provided warranties? Yes — but the seller may resist. Warranties and escrow amounts are negotiated based on the risk profile uncovered during verification.

  • Is an asset purchase always safer than a stock purchase? Asset purchases typically allow buyers to avoid successor liabilities but can be more complex to accomplish (assigning contracts, permits, and licenses).

Professional disclaimer: This content is educational and generalized. It does not replace legal, tax, or accounting advice for specific transactions. Engage experienced M&A counsel and a CPA when verifying and purchasing businesses.

If you want, I can convert this checklist into a printable due-diligence request list or a tailored worksheet for specific industries (retail, manufacturing, software, or service businesses).