What Is Due Diligence for Small Businesses?
We know there are many small business challenges you have to face, but practicing due diligence can help you avoid some of them. Due diligence means checking the backgrounds of people you plan to work with, like:
- Potential investors
Due diligence is also necessary when you’re buying a business.
How Long Does Small Business Due Diligence Take?
Due diligence requires some patience, because gathering information, like intellectual property, takes time. It can take anywhere from a few weeks to a few months to get everything you need. But, you’ll want to do it no matter how long it takes, so you don’t lose money later on.
As a small business owner, you should research any potential vendor’s reliability and finances. Start by checking their references and doing an internet search. You can even contact your local chamber of commerce or the Better Business Bureau. Once you’ve exercised due diligence, you can have confidence in moving forward to work with them.
Hard vs. Soft Due Diligence
There are two types of due diligence:
Hard due diligence involves collecting data, which can include background checks and looking into the finances of a client or vendor.
Soft due diligence means looking into how a company or person will fit into the culture of your small business and seeing how they’d work with others. This can usually take place during an interview.
Although it can be time consuming, due diligence is necessary to help you avoid common small business mistakes.
Due Diligence Small Business Startup Checklist
Before you hire or make any sale agreements, you’ll want to look at your potential business partner’s, client’s or vendor’s:
Inventory: This includes the products they sell. Be sure to see how long their products have sat on their shelves, what condition they’re in, and if they fit your business’ needs.
Tax returns: These can help you figure out how much another business is worth. For help with this, you can ask your certified public accountant (CPA) to review them with you.
Accounts receivable: Determine how financially dependable they are by reviewing their receivables. The longer they’re outstanding, the lower the value of their accounts.
Customers: To get an idea of a business’ future, you can look at their customer information. This includes how many first-time buyers they have and when their busy seasons are. You’ll also want to see where they lost customers during the year.
Debt: Look at their loans and other outstanding expenses. If they have too much debt, their business may not be financially stable.
Marketing: You’ll want to make their advertisements and marketing plans match with the image of your business. For instance, if their ads are too aggressive for your customer base, you may want to reconsider.
Reputation: If they have a negative reputation, this may be a warning that they won’t be easy to work with. You also don’t want your business associated with someone else’s bad reputation.
Insurance: Making sure your clients and vendors have the right insurance coverage is an important long term strategy. If they don’t have product liability coverage, and someone files a lawsuit against them, they may need to close. This would impact the work they do for your business. You can also take this time to see if you need to add any insurance coverage to increase your own business’ protection.
Returns: If they have a lot of customers returning products they bought, you’ll want to investigate why.
Prices: For vendors, you’ll want to track price increases for their products. If you see that their costs keep rising, compare them to others in the industry.
Depending on the size your target company, vendor or client, you may be able to have their human resources department help you get the information you need. Be sure to practice due diligence during all your business activities.
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