I'm getting ready to list my business in about a year and want to understand what buyers actually flag during due diligence. Not looking for textbook answers, what are the real things that spook buyers or make them walk away? I run a small service company with about 12 employees if that helps.
Due Diligence
What red flags do buyers look for during due diligence?
Messy financials are the biggest one. If your books don't match your tax returns, buyers get nervous fast. I've seen deals stall just because the P&L was cobbled together in a spreadsheet with no backup.
Customer concentration. If one client is more than 20-25% of revenue, that's a huge red flag. Buyers worry that client walks and the business collapses. They'll dig into contracts and ask about relationships with those key accounts.
Undocumented processes. I looked at buying a landscaping company once where everything lived in the owner's head. No SOPs, no training materials. The buyer basically said the business was worthless without the owner staying on for years.
The customer concentration point worries me. We have one contract that's about 30% of revenue. Is that an automatic dealbreaker or can it be worked around?
Not automatic, but it'll affect valuation. Buyers will want to see a long-term contract in writing and probably ask for an earn-out or holdback. If the relationship is solid and documented, it's manageable. If it's handshake-based, that's a problem.
Employee turnover. High turnover in a service business signals something is wrong with management or pay. Buyers will look at payroll records and ask why people leave. Also if key employees have no non-compete or retention plan, that's a flag.
I'll add pending litigation or unresolved disputes. Even small stuff like a former employee threatening a claim. Buyers hate surprises in legal. Also any regulatory issues specific to your industry.
Good to know. What about personal expenses run through the business? I have a truck and some travel that's partl personal. Is that something that gets flagged?
it gets flagged, but it's fixable. Buyers will add those back to normalize earnings. The issue is if it's excessive or unclear. Just be upfront and have a clean list of what's personal versus business. Hiding it is worse than having it.