Due Diligence Checklist for Small Business Acquisitions

How to Use This Checklist

This due diligence checklist covers 8 key dimensions that a search fund entrepreneur or SME acquirer should investigate before closing an acquisition. Not every item will apply to every deal - adapt the checklist to your target company's industry, size, and jurisdiction.

For each dimension, we provide the key questions to ask, the documents to request, and common red flags to watch for. Prioritize items based on materiality: a $2M EBITDA services company will have different risk areas than a $5M EBITDA manufacturing business.

Pro tip: Set up a virtual data room (VDR) early and organize documents by these categories. Most deals require 4-8 weeks of diligence. Start with financial DD and the Quality of Earnings analysis, as these drive the most deal-critical insights.

1. Financial Due Diligence

Financial DD is the foundation of any acquisition. It validates the earnings, cash flow, and balance sheet that underpin your valuation.

Documents to Request

• Audited or reviewed financial statements (3-5 years)
• Monthly P&L, balance sheet, and cash flow statements (trailing 24 months)
• Tax returns (3-5 years, all entities)
• General ledger and chart of accounts
• Accounts receivable aging report (current + trailing 12 months)
• Accounts payable aging report
• Inventory listing and valuation methodology
• Capital expenditure schedule (historical and planned)
• Debt schedule - all outstanding loans, lines of credit, and leases
• Revenue by customer, product/service, and geography (trailing 3 years)

Key Questions

• What is the normalized EBITDA after adjusting for owner compensation, one-time items, and related-party transactions?
• Is revenue recurring, contractual, or project-based? What is the customer concentration risk?
• Are there any off-balance-sheet liabilities (operating leases, guarantees, pending claims)?
• What is the historical working capital cycle? Are there seasonal patterns?
• Has a Quality of Earnings (QoE) analysis been performed? (If not, commission one.)
• Are there any deferred revenue or prepaid expense items that distort cash flow?
• What is the normalized level of capital expenditure required to maintain the business?

Red Flags

• Revenue concentrated in fewer than 3 customers (>30% of revenue from a single customer)
• Significant discrepancies between tax returns and financial statements
• Declining margins without clear explanation
• Large or growing aged receivables (>90 days)
• Frequent changes in accounting policies or methods
• Owner perks and personal expenses run through the business that are hard to verify

2. Legal Due Diligence

Legal DD identifies liabilities, contractual risks, and structural issues that could affect the transaction or create post-closing exposure.

Documents to Request

• Corporate formation documents (articles of incorporation, bylaws, operating agreement)
• Shareholder/member agreements and cap table
• All material contracts (customer, vendor, partnership agreements)
• Lease agreements (real estate, equipment)
• Pending or threatened litigation, arbitration, or regulatory proceedings
• Intellectual property registrations (patents, trademarks, copyrights)
• Licensing agreements (inbound and outbound)
• Insurance policies (general liability, D&O, key-man, property)
• Regulatory permits and licenses
• Consent and change-of-control provisions in material contracts

Key Questions

• Are there any change-of-control provisions in key contracts that could be triggered by the acquisition?
• Is the company in good standing in all jurisdictions where it operates?
• Are there any non-compete or non-solicitation agreements with key employees?
• Is the company's IP properly assigned and protected?
• Are there any outstanding or threatened claims, lawsuits, or regulatory actions?
• Do any contracts contain most-favored-nation (MFN) clauses or exclusivity provisions?

Red Flags

• Key customer contracts with 30-day termination clauses
• Unregistered or disputed intellectual property
• Ongoing or recently settled litigation
• Missing or unsigned contracts for major relationships
• Non-compete agreements that could restrict the business post-acquisition

3. Tax Due Diligence

Tax DD ensures there are no hidden liabilities and helps structure the deal tax-efficiently.

Documents to Request

• Federal, state, and local tax returns (3-5 years)
• Sales and use tax filings and nexus analysis
• Payroll tax filings (940, 941 in the US)
• Any IRS or tax authority correspondence, audits, or notices
• Transfer pricing documentation (if applicable)
• R&D tax credit documentation
• Property tax assessments

Key Questions

• Has the company been audited by any tax authority in the past 5 years?
• Are there any outstanding tax liabilities or payment plans?
• Does the company have proper sales tax nexus compliance in all states where it operates?
• What is the optimal deal structure from a tax perspective (asset vs. equity purchase)?
• Are there any tax attributes (NOLs, credits) that could be affected by the change in ownership?
• In the UK: Is there potential exposure under IR35 for contractor relationships?
• In France/Germany: Are social security contributions properly calculated and paid?

Red Flags

• Unfiled returns or missing tax documentation
• Aggressive tax positions or questionable deductions
• Multi-state operations without proper nexus analysis
• 1099 contractor misclassification risk

4. Commercial Due Diligence

Commercial DD validates the market opportunity, competitive position, and growth prospects that underpin your investment thesis.

Documents to Request

• Customer list with revenue, tenure, and contract terms
• Sales pipeline and backlog reports
• Marketing materials and brand assets
• Competitor analysis (internal assessments)
• Pricing history and discount schedules
• Customer satisfaction surveys or NPS data
• Sales team compensation plans and performance data

Key Questions

• What is the customer retention rate over the past 3-5 years?
• How does the company win new business? (inbound vs. outbound, referrals vs. marketing)
• What is the competitive environment and the company's sustainable differentiation?
• Are there obvious expansion opportunities (new geographies, products, adjacencies)?
• What would happen to revenue if the owner/founder left?
• Conduct reference calls with 5-10 key customers (with seller permission)

Red Flags

• High customer churn or declining win rates
• Revenue heavily tied to the owner's personal relationships
• Pricing pressure from larger competitors or commoditization trends
• Declining total addressable market (TAM)

5. Operational Due Diligence

Operational DD examines the processes, infrastructure, and assets that deliver the company's products or services.

Documents to Request

• Organizational chart and headcount by function
• Key vendor and supplier contracts
• Facility layouts, lease terms, and condition reports
• Equipment list with age, condition, and maintenance schedules
• Quality management documentation (ISO certifications, SOPs)
• Supply chain overview and single-source dependencies
• Business continuity and disaster recovery plans

Key Questions

• Are there key-person dependencies in operations? What happens if the plant manager or lead technician leaves?
• Are there deferred maintenance or capital expenditure needs?
• How reliant is the business on a single vendor or supplier?
• Are facilities leased or owned? What are the lease renewal terms and timing?
• Are there any environmental liabilities associated with the facilities?
• What is the capacity utilization? Is there room to grow without significant capex?

Red Flags

• Single-source suppliers with no backup
• Aging equipment requiring near-term replacement
• Facility leases expiring within 12 months of closing
• No documented processes - everything lives in people's heads

6. Human Resources Due Diligence

People are the most important asset in most SME acquisitions. HR DD ensures you understand the team, their terms, and the culture.

Documents to Request

• Employee roster with roles, tenure, compensation, and bonus structures
• Employment agreements (especially for key employees)
• Non-compete and non-solicitation agreements
• Employee handbook and HR policies
• Benefit plans (health, retirement, equity/profit-sharing)
• Workers' compensation claims history
• EEOC complaints or employment-related litigation
• Turnover data (trailing 3 years)

Key Questions

• Which employees are critical to operations and customer relationships?
• What is the total fully-loaded cost of the workforce (salary + benefits + taxes)?
• Are there any pending or threatened employment claims?
• What is employee turnover, and what are the reasons for recent departures?
• Are compensation levels competitive with the local market?
• How will key employees react to the ownership change? (Plan retention conversations.)
• Are any employees approaching retirement who hold critical knowledge?

Red Flags

• High turnover in key positions
• Underfunded retirement or benefit obligations
• Key employees without non-competes who could leave and compete
• Misclassified independent contractors
• No formal HR policies or documentation

7. IT & Technology Due Diligence

Even in traditional industries, technology infrastructure increasingly drives operational efficiency and competitive advantage.

Documents to Request

• IT systems inventory (ERP, CRM, accounting software, custom applications)
• Software licensing agreements and subscription costs
• Network architecture and infrastructure documentation
• Cybersecurity policies and incident history
• Data backup and disaster recovery procedures
• Website and domain ownership documentation
• Source code ownership and developer agreements (if proprietary software)

Key Questions

• What is the annual IT spend (hardware, software, support)?
• Are systems current and supported, or are there end-of-life components?
• Has the company experienced any data breaches or cybersecurity incidents?
• Is the company compliant with relevant data protection regulations (GDPR, CCPA)?
• Are there any proprietary systems that are poorly documented or reliant on a single developer?
• What is the tech debt situation? Are there known issues being deferred?

Red Flags

• Critical systems running on unsupported or end-of-life software
• No cybersecurity policies or incident response plan
• Proprietary code written by a single developer with no documentation
• Non-compliant data handling (especially in regulated industries or EU operations)

8. ESG & Sustainability Due Diligence

Increasingly relevant for all sizes of acquisition, ESG DD identifies environmental liabilities, social risks, and governance gaps.

Documents to Request

• Environmental compliance records and permits
• Phase I/II environmental site assessments (if real estate is involved)
• Health and safety records (OSHA logs in the US, HSE in the UK)
• Sustainability reporting or ESG disclosures (if any)
• Board meeting minutes and governance documentation
• Related-party transaction disclosure
• Anti-bribery and anti-corruption policies

Key Questions

• Are there any known or potential environmental contamination issues?
• Has the company received any environmental violations or fines?
• What is the workplace safety record? Any serious incidents in the past 5 years?
• Are there related-party transactions that should be eliminated post-acquisition?
• For EU acquisitions: Is the company subject to the EU Corporate Sustainability Reporting Directive?
• Does the company have exposure to climate-related risks (supply chain, physical assets)?

Red Flags

• History of environmental violations or unresolved contamination
• Poor safety record or pending OSHA/HSE investigations
• Related-party transactions that benefit the owner at the company's expense
• No governance documentation (minutes, resolutions)

Due Diligence Timeline

A typical DD process for a $1-10M EBITDA acquisition takes 4-8 weeks. Here is a recommended sequencing:

• Week 1-2: Financial DD and QoE engagement. Begin legal document review. Set up VDR.
• Week 2-3: Tax DD. Commercial DD (customer calls). HR review.
• Week 3-4: Operational site visits. IT assessment. Environmental review.
• Week 4-6: QoE report delivery. Working capital analysis. Final legal review.
• Week 5-8: Resolve open issues. Negotiate purchase agreement adjustments. Pre-closing preparations.