By Jaap van der Westhuizen, AGA(SA)
PPRA-registered business broker | Cape Business Bureau
Buying an established business can give a purchaser access to customers, employees, systems, suppliers, premises and an existing income stream. It can also expose the buyer to risks that are not apparent from the advertisement or first meeting.
Due diligence is the buyer’s structured investigation of the business and the information supplied by the seller. Its purpose is to test the commercial case, verify important facts, identify risks and determine whether the proposed price and transaction terms remain acceptable.
Due diligence should not be approached as a box-ticking exercise or an attempt to prove that the seller is wrong. It is a disciplined process for deciding whether to proceed, renegotiate, add protection to the agreement or withdraw.
The depth of the investigation will depend on the size, industry, structure and risk of the business. This checklist provides a practical South African starting point, but it does not replace professional accounting, tax, legal, labour or technical advice.
If you are still comparing opportunities, begin with Cape Business Bureau’s current businesses for sale and complete the confidential enquiry process before requesting detailed records.
Before due diligence begins
The buyer should first understand the opportunity at a high level. Detailed records should normally be requested only after the buyer has been screened, the required non-disclosure agreement has been signed and the seller is satisfied that the enquiry is genuine.
Before committing time and professional fees, confirm:
- The type of business and location
- Asking price
- Broad turnover and profit information
- Owner involvement
- Staff complement
- Premises arrangement
- Reason for sale
- Assets and stock included
- Buyer’s available capital and funding requirements
- Any obvious licence, qualification or experience requirements
If the opportunity does not fit the buyer’s skills, available capital or desired level of involvement, it may be better to stop before requesting highly confidential information.
1. Clarify what you are buying
The buyer must understand the proposed transaction. A purchase may involve the operating assets and business as a going concern, or shares or members’ interest in the entity that owns the business.
Clarify:
- Which legal entity or person owns the business
- Whether the proposed sale is of assets, the business operation, shares or members’ interest
- Trading name and intellectual property included
- Assets and stock included
- Treatment of cash, debtors, creditors and working capital
- Liabilities that remain with the seller or entity
- Property included or leased separately
- Contracts, licences and permits requiring consent or transfer
- Seller support after takeover
- Proposed restraint of trade
- Effective date and takeover date
The transaction structure can affect tax, VAT, employees, contracts and liability exposure. The buyer’s attorney and tax adviser should review it before a binding agreement is signed.
2. Build the right professional team
A business broker coordinates communication and helps the parties deal with commercial issues, but the buyer remains responsible for obtaining independent advice.
Depending on the transaction, the buyer may require:
- Accountant or financial due-diligence adviser
- Commercial attorney
- Tax adviser
- Labour specialist
- Industry or technical specialist
- Property, environmental or licensing specialist
- Finance provider
Agree the investigation scope and responsibilities. A checklist is useful, but it is not a substitute for professional judgement.
3. Verify ownership and corporate standing
Confirm the identity and authority of the seller.
Review, where applicable:
- CIPC registration documents
- Founding statement or Memorandum of Incorporation
- Directors, members and shareholders
- Share register or members’ interest information
- Beneficial ownership information
- Annual-return status
- Securities or beneficial-interest registers
- Shareholder or association agreements
- Resolutions authorising the transaction
- Subsidiaries and related entities
- Restrictions, pledges or options affecting ownership
- B-BBEE documentation where commercially relevant
CIPC currently connects annual-return compliance with beneficial ownership declarations and applicable ownership registers for companies and close corporations.[1] Verify the records independently and confirm that the person negotiating the sale has authority to do so.
Where shares or members’ interest are being acquired, the buyer’s advisers should investigate the entity’s history and liabilities carefully. Acquiring an entity is different from selecting individual operating assets.
4. Test the quality of the financial information
Do not assess a business only from turnover, the asking price or a profit number in an advertisement.
Request and review:
- Financial statements for the latest three financial years, where available
- Current management accounts
- Monthly turnover and gross profit
- Profit and loss statements
- Balance sheets
- Cash-flow information
- Trial balance or detailed ledger where required
- Debtors and creditors age analysis
- Bank statements
- Budgets and forecasts
- Capital expenditure history
- Loan, lease and finance balances
- Related-party accounts
Compare performance over time. Investigate:
- Material changes in turnover
- Declining gross margin
- Expenses that appear unusually low or high
- Large journal entries
- Once-off income
- Unusual year-end adjustments
- Negative cash flow despite reported profit
- Growing debtors or slow stock
- Liabilities not reflected in the asking price presentation
The question is not only whether the historic figures are correct. The buyer must also decide whether the earnings are sustainable after the seller leaves.
5. Reconcile revenue and cash generation
Revenue should be tested against evidence that is difficult to manufacture consistently.
Depending on the business, compare:
- Accounting-system sales reports
- VAT returns
- Bank deposits
- Point-of-sale reports
- Customer invoices
- Debtor receipts
- Merchant-service statements
- Online-platform reports
- Order books and service agreements
Where the business handles significant cash sales, understand the controls over cash collection, recording and banking. Claims about unrecorded turnover should not be treated as verified earnings.
Identify whether revenue is:
- Contracted or informal
- Recurring or once-off
- Spread across many customers or concentrated
- Dependent on the owner
- Seasonal
- Affected by discounts, credits or returns
6. Review normalised earnings and owner adjustments
The seller may present normalised earnings or seller’s discretionary earnings by adjusting the reported profit.
Test every adjustment:
- Is it identifiable in the accounts?
- Is supporting evidence available?
- Is it genuinely non-recurring?
- Will the buyer incur the cost after takeover?
- Does it relate to the owner’s personal circumstances?
- Has any replacement salary been allowed for?
- Are finance costs and tax being treated consistently?
Owner remuneration may be added back for presentation purposes, but the buyer may need to employ a manager or perform that work personally. The replacement cost should be considered when assessing the future return.
Build an independent view of maintainable earnings rather than accepting the seller’s adjusted number without testing it.
7. Investigate tax and statutory compliance
Review the registrations and obligations applicable to the business.
The investigation may include:
- Income-tax returns and assessments
- VAT registration, returns and reconciliations
- PAYE, UIF and Skills Development Levy records where applicable
- Tax Compliance Status information
- SARS correspondence
- Audits, objections, disputes or payment arrangements
- Customs and excise matters where applicable
- Industry levies or statutory obligations
SARS identifies corporate income tax, VAT, PAYE and related employer obligations among the areas relevant to businesses and employers.[3] SARS also states that VAT vendors must maintain proper accounting records and retain applicable VAT documentation for the required period.[2]
Do not rely only on a historic tax-clearance document. Ask the tax adviser to assess current filings, outstanding liabilities and transaction-specific tax implications.
8. Assess customers and the durability of revenue
Review:
- Customer concentration
- Revenue from the largest customers
- Customer tenure
- Recurring revenue
- Contracts and service-level agreements
- Contract expiry and termination rights
- Pricing arrangements
- Debtor-payment behaviour
- Complaints, credits and returns
- Lost customers
- Pipeline and order book
- Transferability and change-of-control clauses
Speak to customers only with the seller’s written agreement and at the correct stage of the transaction. Premature contact can damage the business and breach confidentiality.
Ask whether customers buy from the business because of its systems and service, or mainly because of the owner’s personal relationships.
9. Assess suppliers and purchasing risk
Review:
- Main suppliers
- Percentage of purchases from each key supplier
- Payment terms
- Rebates and volume discounts
- Exclusivity arrangements
- Outstanding balances
- Supply disputes
- Minimum-order requirements
- Import and currency exposure
- Alternative sources of supply
- Transferability of accounts and credit terms
A favourable supplier arrangement may not automatically continue after the sale. Confirm whether the buyer must apply for a new account, provide security or accept different terms.
10. Verify assets, stock and working capital
For material assets, confirm:
- Existence
- Ownership
- Condition
- Age and remaining useful life
- Maintenance history
- Current market value
- Replacement requirement
- Finance or lease obligations
- Security, liens or notarial bonds
- Insurance cover
For stock and work in progress, investigate:
- Valuation method
- Latest physical count
- Obsolete, damaged or slow-moving items
- Consignment stock
- Stock financed or owned by suppliers
- Seasonal stock requirements
- Proposed takeover stock count
Working capital is often overlooked. Determine how much cash, stock and debtor funding the buyer will require after paying the purchase price. Confirm which debtors, creditors and cash balances are included or excluded.
11. Review employees and owner dependence
Prepare a confidential understanding of:
- Staff complement
- Roles and responsibilities
- Length of service
- Remuneration and benefits
- Leave balances
- Bonuses and commissions
- Employment agreements
- Key-person dependencies
- Disputes and disciplinary matters
- Required qualifications
- Payroll and statutory records
- Organisational structure
Document the owner’s role, weekly hours, customer relationships, technical work and decision-making responsibilities.
Ask:
- What does the owner do that is not recorded in a job description?
- Who can run the business if the owner is absent?
- Which relationships must be transferred?
- Will a replacement manager or technical employee be required?
- What will that replacement cost?
Employee consequences can depend on the structure of the transaction and applicable labour law. The buyer should obtain labour-law advice before relying on assumptions about which employees or obligations will transfer.
12. Examine the premises and lease
For leased premises, review:
- Signed lease and amendments
- Lease expiry
- Renewal options
- Rental and escalation
- Operating costs
- Deposits and guarantees
- Permitted use and zoning
- Maintenance obligations
- Breaches, disputes or notices
- Assignment and change-of-control clauses
- Landlord consent
- Requirements for a new lease
- Backup power, utilities and access
Consider whether the business can afford the premises and whether its customer base is location-dependent. A short remaining lease or unwilling landlord can be a major transaction risk.
If property is included, obtain suitable legal, financial, valuation and technical advice. If the property is excluded, agree the proposed lease terms before treating the business price as final.
13. Review material contracts, licences and intellectual property
Review contracts that allow the business to operate or earn income:
- Customer contracts
- Supplier and distribution agreements
- Franchise agreements
- Agency agreements
- Equipment and vehicle leases
- Finance agreements
- Software licences
- Insurance policies
- Maintenance agreements
- Restraints and confidentiality agreements
- Industry permits and operating licences
For each contract, check:
- Parties
- Term and renewal
- Termination rights
- Breach position
- Pricing commitments
- Exclusivity
- Assignment or change-of-control provisions
- Consent required
Confirm ownership and transferability of:
- Trading name
- Trademarks
- Domain names
- Website
- Telephone numbers
- Social-media accounts
- Designs, content and databases
- Proprietary systems and processes
Do not assume that a domain, software account or social-media page belongs to the business merely because the business uses it.
14. Investigate systems, technology and information security
Understand the systems required to operate the business:
- Accounting
- Point of sale
- Payroll
- Customer relationship management
- Stock control
- Booking or production
- Website and e-commerce
- Backups
- Cybersecurity
- User permissions
- Third-party hosting and licences
Ask about outages, data loss, security incidents and unsupported software. Confirm the cost of licences after takeover and whether accounts can be transferred.
The Information Regulator’s POPIA material addresses security measures protecting the integrity and confidentiality of personal information.[4] Customer and employee databases should be handled through controlled access. A buyer should request only the personal information genuinely required and obtain advice on lawful transfer and processing.
Passwords and administrator credentials should normally transfer through a secure handover process after the relevant conditions have been fulfilled.
15. Check operations, maintenance and capacity
Review how the business performs its daily work:
- Operating procedures
- Quality controls
- Production or service capacity
- Maintenance schedules
- Health and safety
- Required technical skills
- Key-person dependencies
- Supplier lead times
- Stock controls
- Customer-service processes
- Complaints handling
- Business continuity and backup arrangements
Conduct a site visit at an agreed time. Compare what you observe with the seller’s description, asset list and employee information.
If growth is part of the investment case, test whether the business has the staff, premises, equipment, working capital and demand needed to achieve it.
16. Review market position and competition
Consider:
- Target customers
- Competitors
- Barriers to entry
- Pricing power
- Industry trends
- Seasonality
- Regulatory changes
- Technology risk
- Dependence on one product or service
- Reputation and online reviews
- Opportunities and threats
A growing industry does not automatically mean the particular business will grow. Test the assumptions against its actual capabilities and customer behaviour.
17. Identify claims, disputes and contingent liabilities
Ask for a schedule of:
- Current or threatened litigation
- Customer and supplier disputes
- Employee disputes
- Tax disputes
- Regulatory investigations
- Insurance claims
- Product or service warranty claims
- Personal guarantees and sureties
- Environmental or safety incidents
- Related-party liabilities
- Contingent liabilities
The buyer’s attorney should decide what protection is required through conditions, disclosures, warranties, indemnities or adjustments to the transaction structure.
18. Test the asking price and funding requirement
Once the information has been reviewed, revisit the commercial case.
Consider:
- Maintainable earnings
- Replacement salary for the owner’s role
- Capital expenditure required
- Working-capital requirement
- Stock adjustment
- Debt or liabilities assumed
- Customer and supplier concentration
- Lease risk
- Key-person risk
- Funding cost
- Transition requirements
- Risk-adjusted return
The advertised asking price is a starting point for evaluation. Due diligence may support the price, identify grounds for revised terms or show that the opportunity is not suitable.
Make sure that the funding plan covers more than the purchase price. The buyer may need money for stock, deposits, professional costs, working capital, repairs and an initial trading buffer.
19. Record findings and deal responses
Maintain a due-diligence issues list showing:
- Question or issue
- Document reviewed
- Seller’s response
- Adviser responsible
- Financial or operational effect
- Required follow-up
- Proposed deal response
- Resolution status
A finding does not always require the buyer to withdraw. Depending on its seriousness, the response may be:
- Obtain further evidence
- Make completion conditional on correction
- Adjust the price
- Adjust working capital or stock
- Require a warranty or indemnity
- Hold back part of the price
- Require landlord, funder or regulatory approval
- Extend handover support
- Restructure the transaction
- Withdraw where the risk cannot be accepted
Keep evidence supporting any proposed renegotiation. A vague concern is less persuasive than a documented issue with a measurable effect.
20. Respect confidentiality during the investigation
The Cape Business Bureau non-disclosure process requires prospective purchasers to keep business information confidential, avoid unauthorised contact with the seller’s employees, customers and suppliers, and conduct their own investigation.[5]
The buyer should:
- Use the information only to evaluate the proposed purchase
- Share it only with authorised professional advisers
- Keep it securely
- Avoid contacting stakeholders without written approval
- Return or delete it if the transaction does not proceed
- Follow the agreed process for questions and site visits
Confidentiality continues to matter even if the buyer decides not to proceed.
Buyer due-diligence red flags
Investigate carefully if you find:
- Missing financial statements or management accounts
- Sales that do not reconcile to bank, VAT or operational records
- Significant cash income that cannot be verified
- Large unsupported profit adjustments
- Declining turnover or gross margin without a credible explanation
- One customer or supplier dominating the business
- An expiring or disputed lease
- Assets that are financed, obsolete or not owned by the seller
- Material licences or contracts that cannot transfer
- Undisclosed tax, employee or legal disputes
- Significant owner dependence
- Unexplained staff turnover
- Forecasts presented as guaranteed performance
- Pressure to skip professional review or pay before conditions are clear
- Inconsistent explanations from the seller
- Refusal to provide reasonable evidence after confidentiality protections are in place
A red flag is a reason to investigate, not automatically proof of wrongdoing. Consider the evidence and obtain suitable advice.
Buyer’s practical due-diligence checklist
Before completing the purchase, confirm that you have:
- Identified exactly what is being acquired
- Verified the seller’s identity and authority
- Reviewed corporate and ownership records
- Tested historical and current financial information
- Reconciled material revenue to supporting records
- Built an independent view of maintainable earnings
- Reviewed tax and statutory compliance
- Assessed customer and supplier concentration
- Verified material assets and stock
- Calculated working-capital requirements
- Understood employees and owner dependence
- Reviewed the premises and lease
- Checked contracts, licences and intellectual property
- Assessed systems, cybersecurity and data obligations
- Investigated operations, maintenance and capacity
- Considered the market and competition
- Reviewed disputes and contingent liabilities
- Tested the price and finance structure
- Recorded unresolved issues in the offer or agreement
- Prepared a realistic transition and handover plan
- Obtained professional advice appropriate to the transaction
Final thoughts
Good due diligence does not remove all business risk. It allows the buyer to understand the risks, decide which ones are acceptable and record appropriate protections before committing to the transaction.
The process should be thorough but proportionate. Concentrate on the matters that affect ownership, earnings, cash flow, continuity, liability and the buyer’s ability to operate the business after takeover.
For the corresponding preparation from the owner’s side, see the Seller’s Due Diligence Checklist.
Considering buying a business? View Cape Business Bureau’s current business opportunities and contact a CBB broker about your acquisition criteria and the confidential enquiry process.
About the author
Jaap van der Westhuizen, AGA(SA) is a PPRA-registered business broker with more than 25 years of commercial experience. He assists business owners and prospective purchasers through the practical stages of business sales and acquisitions at Cape Business Bureau.
This article provides general business-broker guidance and does not constitute legal, tax, accounting, labour, data-protection, technical or financial advice. Every transaction is different. Buyers should conduct their own investigation and obtain advice from suitably qualified professionals before making or accepting a binding commitment.
Sources
[2] SARS Obligations of a VAT Vendor
[3] SARS Businesses and Employers
