Business Due Diligence When Buying an Existing Business

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Business Due Diligence When Buying an Existing Business

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Buying an existing business can be a faster way to enter the market than starting from scratch. You gain an established customer base, trained staff, systems, and often immediate cash flow. But the opportunity comes with risks. Due diligence is the process that helps you understand what you are buying and whether the price, terms, and risks align with your goals.

This guide explains how due diligence works, what areas to focus on, common pitfalls, and how professional advice helps reduce risk. It is tailored for Australian business buyers and written with a practical, step-by-step approach.

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Why Due Diligence Matters

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Due diligence is the detailed investigation of a business before you commit to buying it. It is more than a financial review. It covers legal, operational, tax, contractual, and even cultural aspects. The purpose is to confirm that what is represented by the seller is accurate and that there are no hidden surprises.

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Key reasons due diligence is important:

• Confirms the value of the business
• Identifies liabilities and risks
• Highlights compliance issues
• Ensures contracts and assets are valid
• Provides leverage to negotiate terms
• Builds confidence in your decision

Skipping due diligence or rushing through it increases the chance of overpaying, inheriting hidden debts, or buying a business that does not align with your goals.

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Preparing for Due Diligence

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Before you start, clarify your objectives.

• Are you buying for growth, diversification, or entry into an industry?
• How does the business fit with your skills, experience, and financial position?
• What is your appetite for risk and your ability to invest further after purchase?

Once you know your purpose, build a due diligence plan. This should cover financial, legal, operational, tax, and commercial areas. Create a checklist of documents, contracts, and questions. Engage accountants, lawyers, and advisers early so they can help review the material.

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Step 1: Ownership and Structure Verification

The first step is confirming that the seller owns the business and has the right to sell it.

Key checks:

• Company search through ASIC to confirm directors and shareholders
• Review of business name registration and ownership
• Domain names, websites, and digital assets ownership
• Trade marks and intellectual property registrations
• Personal Property Securities Register (PPSR) to identify encumbrances or charges
• Shareholder agreements and trust deeds if applicable

Ownership issues can derail a transaction if not clarified early. For example, intellectual property might be owned by a related entity rather than the business itself. If this is missed, you risk losing control of brand assets after purchase.

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Step 2: Financial Due Diligence

Financial review is central. You need to know whether the reported profits and cash flows are accurate.

Documents to request:

• At least four years of financial statements
• Business Activity Statements (BAS)
• Income tax returns
• Management reports
• Budgets and forecasts
• List of debtors and creditors
• Bank statements

When reviewing financials, focus on:

• Revenue trends: seasonal fluctuations, customer concentration
• Gross profit margins: compare year on year
• Operating expenses: identify unusual or one-off items
• Cash flow: review bank reconciliations and debtor collections
• Tax compliance: confirm GST, PAYG, superannuation, and payroll tax obligations

Financial due diligence is not only about validating profit. It also shows the sustainability of cash flow and whether the business depends on a few customers or suppliers.

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Step 3: Legal and Contractual Review

The next layer is confirming the legal standing of the business.

Key areas:

• Supplier contracts: terms, renewal dates, exclusivity, and pricing obligations
• Customer contracts: length, assignment rights, and termination clauses
• Employment agreements: wages, entitlements, awards, and compliance
• Lease agreements: rent, options to renew, make-good obligations
• Licences and permits: industry-specific approvals and registrations
• Litigation: check for disputes, claims, or historical issues

Legal due diligence ensures that what you think you are buying is transferable. For example, some supplier or customer contracts may not automatically transfer to a new owner. Missing this detail can mean losing key revenue streams after settlement.

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Step 4: Operational Due Diligence

Operations often reveal the true state of a business.

Review areas include:

• Staffing: skills, morale, turnover rates, training
• Systems: accounting software, customer management, processes
• Technology: IT infrastructure, security, and digital presence
• Supply chain: reliability, costs, risks of disruption
• Facilities: equipment condition, maintenance, safety compliance
• Inventory: levels, valuation, obsolescence, and storage

Operational issues can affect long-term profitability. A business with outdated systems or poor staff culture may require significant investment to fix after purchase.

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Step 5: Tax and Compliance Review

Tax obligations are a critical part of due diligence. Unpaid liabilities transfer with the business.

Checks include:

• GST and BAS lodgements up to date
• PAYG withholding obligations met
• Superannuation paid for all employees
• Payroll tax compliance where applicable
• Income tax assessments lodged and paid
• Fringe Benefits Tax (FBT) obligations
• Any outstanding ATO audits or disputes

Non-compliance in tax can result in penalties, interest, and director liabilities. A professional tax review reduces this risk.

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Step 6: Structure of the Transaction

There are two common structures when buying a business:

• Asset purchase: You buy the business assets, not the company. This limits exposure to past liabilities but requires setting up new contracts, licences, and employee agreements.
• Share purchase: You buy the shares of the company. This provides continuity of contracts but transfers all historical liabilities to you.

Choosing the right structure requires advice from accountants and lawyers. Each option has tax, legal, and operational consequences.

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Step 7: Market and Commercial Review

Financial and legal checks are not enough. You must test whether the business model is sustainable.

Consider:

• Market trends and growth potential
• Competitor activity and market share
• Customer demographics and loyalty
• Reputation of the brand and goodwill value
• Barriers to entry for new competitors
• Risks of industry regulation or disruption

A business with declining demand may look profitable today but face long-term decline. Commercial due diligence balances the numbers with market reality.

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Step 8: Risk Assessment and Valuation

After reviewing all areas, consolidate findings into a risk assessment.

• Identify strengths and opportunities
• Highlight weaknesses and threats
• Quantify financial risks
• Compare asking price with valuation
• Consider alternative scenarios such as reduced revenue or higher costs

Use this assessment to decide whether to proceed, renegotiate, or walk away.

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Step 9: Negotiation and Contract Protections

Due diligence often uncovers issues. These do not always kill a deal but give grounds to adjust terms.

Options include:

• Reducing the purchase price
• Seeking vendor warranties and indemnities
• Deferring part of the payment until performance is proven
• Requiring the seller to clear debts before settlement

Contract protections safeguard you against future claims or surprises. Always involve legal advisers in drafting and negotiating these terms.

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Common Red Flags

Watch for warning signs during due diligence:

• Declining sales without clear explanation
• Heavy reliance on a single customer or supplier
• Unpaid tax or superannuation liabilities
• Ongoing disputes or litigation
• Inflated inventory or doubtful debtors
• Poor staff morale or high turnover
• Non-transferable licences or key contracts

These do not automatically end the deal, but they require deeper investigation.

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Role of Professional Advisors

Due diligence is complex. Accountants, lawyers, tax agents, and business consultants provide the expertise to review documents and identify risks. Their role includes:

• Reviewing financial statements and tax compliance
• Checking contracts and regulatory obligations
• Advising on transaction structure and valuation
• Preparing risk assessments
• Supporting negotiation strategies

Relying only on your own review increases risk. Professional advisors add objectivity and depth.

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How Trinity Accounting Practice Helps

At Trinity Accounting Practice we support clients throughout the business purchase process. Our services include:

• Reviewing financial statements, BAS, and tax compliance
• Identifying risks and liabilities
• Advising on structure and tax efficiency
• Preparing cash flow projections and valuations
• Liaising with lawyers and other advisors
• Supporting negotiations with the vendor

Our experience across industries such as construction, childcare, hospitality, trades, and medical practices allows us to tailor due diligence to your sector.

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Long-Term Benefits of Thorough Due Diligence

Conducting due diligence thoroughly has long-term benefits:

• Reduces risk of costly surprises
• Increases confidence with financiers and investors
• Improves negotiation outcomes
• Provides insight into business strengths and weaknesses
• Sets a clear path for growth after purchase

Skipping or rushing due diligence often leads to regret. Investing the time and resources upfront protects your investment.

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Conclusion

Business due diligence is the foundation of a successful acquisition. It confirms value, highlights risks, and shapes negotiation. Covering financial, legal, tax, operational, and market aspects ensures that your decision is informed and strategic.

Working with experienced accountants and advisors like Trinity Accounting Practice provides clarity and peace of mind. Buying a business is a major step, but with thorough due diligence, it can be the start of sustainable growth.

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☎️ 02 9543 6804
📍 159 Stoney Creek Road Beverly Hills NSW 2209
🌐 www.trinitygroup.com.au
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