Due diligence checklist for buying a small business: what to ask the seller for

When you buy an owner-run business, most of what you know comes from the seller. The SBA suggests having an attorney and an accountant evaluate the letter of intent, contracts and leases, financial statements, tax returns and the sales agreement (SBA, Buy an existing business or franchise). This checklist turns that advice into a request list you can send.

Seller’s discretionary earnings is the profit figure brokers use for small businesses: net profit with the owner’s pay and personal expenses added back. Every add-back should come with a receipt or a ledger line, because it raises the price you pay.

If the target is a larger company with outside investors, use the M&A checklist instead.

The seller and the seller’s CPA or bookkeeper produce the returns, statements and payroll files. The IRS produces the transcripts, once the seller signs the request. The secretary of state holds lien filings and good standing, the landlord gives consent to assign the lease, and each licensing agency says whether its license transfers.

1. Agree the review period and contingencies in the letter of intent.
2. Send the seller the request email below, and ask for a signed transcript request with it.
3. Run the lien search in the state where the seller’s company was organized.
4. Fill in the sales check below from returns, bank statements and sales tax filings.
5. Ask the landlord and each licensing agency about transfer before you waive contingencies.

• Paying on add-backs the seller cannot document.
• Taking returns from the seller with no transcripts to compare them against.
• Missing a merchant cash advance, which can sit on the bank statements and not on the balance sheet.
• Assuming the lease, the liquor license or the franchise passes to you without consent.
• Skipping the state tax clearance, then receiving the seller’s sales tax bill.

Ask for the same three years across returns, statements and bank records, so you can compare them line by line.

• Business returns for three years: Schedule C, Form 1065, Form 1120-S or Form 1120, with all schedules.
• Annual profit and loss statements and balance sheets, plus the current year to date.
• Business bank statements and merchant processing statements for the same months.
• Sales tax returns and payroll filings, including Form 941 and Form 940.
• Receivables and payables agings, and a customer list showing who buys the most.
• Inventory count, equipment list with condition, and vehicle titles.
• Loan statements, equipment leases and any merchant cash advance agreement.
• The lease, franchise agreement, key supplier contracts and customer contracts.
• Licenses and permits, such as business, health, liquor or professional licenses.
• Staff roster with pay rates and tenure, contractor list, benefits and accrued leave.
• Insurance policies and loss runs, and any open claims or complaints.

The core test in a small deal is simple: do the sales on the returns match what reached the bank? Build one row per month, for example in a spreadsheet, and look for gaps.

A tax transcript is the IRS’s own summary of a filed return or an account. Form 4506-T requests return, account, wage and income and record of account transcripts (IRS, About Form 4506-T, Request for Transcript of Tax Return). Form 8821 instead lets a firm the seller names, such as your CPA, receive the seller’s tax information for the years listed (IRS, About Form 8821, Tax Information Authorization).

A UCC filing is a public notice that a lender claims a security interest in the business’s assets. A corporation or LLC is located, for this purpose, in the state where it was organized, so search there (UCC § 9-307, Location of debtor (LII)). Add tax lien and judgment searches in the county where the business operates.

Some states can collect a seller’s unpaid sales or payroll taxes from the buyer. In California, for example, the tax agency says buyers can be held responsible for a seller’s unpaid taxes unless a tax clearance certificate is obtained (California Department of Tax and Fee Administration, Closing Out Your Account (Publication 74)). Ask your state revenue department whether it offers a similar certificate, and hold back part of the price until it arrives.

In an asset purchase, buyer and seller each file Form 8594 when the assets make up a trade or business with goodwill (IRS, About Form 8594, Asset Acquisition Statement). Agree the allocation in the purchase agreement so both forms match.

A great location is worth little if the landlord will not let you take over the lease. Ask for the landlord’s written consent to assign, and check the remaining term and renewal options.

Licenses often do not transfer. Health, liquor and professional licenses usually need a new application, so call each agency early. Finish with transition terms, such as a training period, a non-compete and any seller note.

• SBA, Buy an existing business or franchise: An attorney and an accountant can help a buyer create and evaluate the letter of intent, confidentiality agreement, contracts and leases, financial statements, tax returns, sales agreement and purchase price adjustment.
• IRS, About Form 4506-T, Request for Transcript of Tax Return: Form 4506-T requests tax return, tax account, wage and income, record of account and verification of non-filing transcripts.
• IRS, About Form 8821, Tax Information Authorization: Form 8821 authorizes a person or firm the taxpayer designates to inspect or receive the taxpayer’s confidential tax information for the tax types and periods listed.
• UCC § 9-307, Location of debtor (LII): A registered organization organized under the law of a State is located in that State; an individual debtor is located at the principal residence.
• California Department of Tax and Fee Administration, Closing Out Your Account (Publication 74): In California, buyers can be held responsible for a seller’s unpaid taxes unless a tax clearance certificate is obtained.
• IRS, About Form 8594, Asset Acquisition Statement: Both the seller and the purchaser of a group of assets that makes up a trade or business must use Form 8594 when goodwill or going concern value attaches or could attach and the buyer’s basis is set only by the price paid.