The Smart Buyer’s Guide to Legal & Financial Due Diligence in Business Acquisitions

Buying an existing business is a complicated process, but it can be a more cost-effective way for entrepreneurs to get started in an industry or grow their own small business. Most small business owners will need a business loan to buy an existing business to avoid putting a significant dent in their cash flow or working capital. While due diligence is always important, the involvement of a lender makes doing your legal and financial due diligence especially crucial to ensure a deal doesn’t fall through.

Failure to do proper due diligence could cause funding to fall through or worse, saddle you with debt on a losing investment. Today, it’s more important than ever given high rates of inflation and stagnant business earnings in early 2025.

In this article:

• The importance of doing legal and financial due diligence before seeking funding to buy an existing business.
• The types of due diligence you must do to get a loan to buy an existing business.
• The step-by-step process to performing due diligence to ensure you can get a business loan to buy an existing business.

What is Due Diligence?

Due diligence is the process of assessing a transaction to verify facts and identify risk. In mergers and acquisitions (M&A), it’s incredibly important because it’s how you vet an established business to determine its health, track record, and viability as either a standalone business or an addition to your existing operations.

Due diligence will help you determine if the asking price for the business is fair and is a crucial step when seeking a business loan to buy an existing business. It will help determine a fair asking price, identify any liens that may prevent a business purchase, and inform the loan process by determining what business financing options may be available to you based on the acquisition’s risk.

Why Due Diligence Matters

Any business acquisition is a complex process that involves more than just a buyer and seller. You’ll often need a business loan to purchase an existing business, which means a lender is involved as well. Whether it’s a financial institution like a traditional bank or credit union, or an online lender, you’ll need to prove commercial liability to secure a bank loan.

Proper due diligence can help:

• Avoid unforeseen risks: By delving into a business’s balance sheets and tax returns, you can better understand its assets, detect trends in its customer base, and much more. For instance, if foot traffic at its brick-and-mortar stores has been steadily declining and it’s getting dragged down by commercial real estate loans that it can’t afford, you may struggle to secure a business loan to buy the existing business.
• Avoid liabilities: When you buy a business, you buy its liabilities, too. If an established business has legal issues, like regulatory violations or active employment litigation, these disclosures can help you avoid inheriting costly legal headaches. Moreover, a lender may not approve a business loan to buy an existing business if it is embroiled in legal issues.
• Inform your decision-making: Whether you’re trying to expand a new business or figure out the right small business loan to pursue, due diligence provides a wealth of information to give you a deeper understanding of the business’s current state, future potential, and how it may factor into your business plans.
• Gain leverage: With detailed information about the business, you could attempt to adjust the purchase price or renegotiate certain terms and conditions. With strong leverage, you could reduce the necessary loan amount, lowering your repayment obligations after purchasing the business and potentially increasing your eligibility for better interest rates and loan terms.

Types of Due Diligence

Small business buyers should perform several types of due diligence. These include:

• Financial due diligence: To verify the financial health and stability of the company and determine the viability of getting a business loan to buy an existing business. Lenders need to know the investment will have positive returns.
• Legal due diligence: To ensure the company is in compliance with legal and regulatory requirements and does not have any ongoing legal disputes that may complicate the purchase.
• Operational due diligence: To ensure the business’s operational efficiency and scalability, from supply chain management to human resources.
• Commercial due diligence: To understand the company’s market position and competitive landscape to determine its growth potential.
• Technology due diligence: To evaluate the company’s tech stack and IT infrastructure to understand their security and stability.

Each of these types of due diligence are vital for understanding the viability of purchasing a new business, but they are also all factors into a business loan to buy an existing business.

Types of Business Loans to Buy an Existing Business

There are many small business loan options available to business owners interested in business acquisitions. Different loans and lenders may have varying eligibility requirements, but usually, borrowers will need a strong business or personal credit score, a down payment, strong financials, and clear due diligence on the target asset.

Some of the most common types of loans to buy an existing business include:

• Term loans: These conventional loans provide an upfront lump sum in exchange for monthly payments, plus interest, through a specified loan term. They’re good business acquisition loans because they’ll give you the money necessary to meet the business purchase price, plus you may have some extra capital to cover other new business expenses.
• SBA loans: Backed by the United States Small Business Administration (SBA), these loans typically offer the most competitive interest rates and loan terms. However, the application process is rigorous, and SBA lenders usually require an excellent credit history and a minimum amount of time in business. The SBA (7) loan program is the SBA’s most popular.
• Business lines of credit: This flexible funding solution gives you access to a maximum loan amount, but you only pay interest on the amount you withdraw. Since most are revolving, you’ll have access to the full amount after repaying what you’ve withdrawn, just like a business credit card. You can use a line of credit as a business loan to buy an existing business and then fund new costs and expenses as they arise.
• Seller financing: In this unique arrangement, the business seller provides a loan to the buyer to facilitate the purchase. Effectively, they transfer ownership to the buyer in exchange for repayment terms executed over time.

Final Thoughts

Most small business owners don’t have the liquid capital necessary to buy a business outright. You’ll likely need a business loan to buy an existing business. Financial and legal due diligence are absolutely essential whenever you make a major purchase, but especially when you’re dealing with a lender. If you want to get a loan to buy an existing business, you need the lender to be on board, which means showing that you’ve vetted the acquisition for potential risks and its revenue potential.

FAQs about Business Loans to Buy an Existing Business

What is due diligence?

Due diligence is the process a potential buyer takes to verify facts and identify risk before making a major purchase.

What are the primary types of due diligence?

The primary types of due diligence are financial, legal, operational, commercial, and technology due diligence.

Why is due diligence important?

Due diligence is important for several reasons. It can help you identify potential issues with the target company’s accounting, illuminate regulatory or legal compliance issues that may complicate the sale, expose obstacles that may limit the company’s scalability, and much more. While it’s necessary to get a business loan to buy an existing business, it’s also crucial to ensure you’re making a smart purchase.

Do lenders require due diligence for a business loan to buy an existing business?

Yes, virtually all traditional and online lenders will require you to show that you’ve done your due diligence on a business before approving a loan application.

How long does due diligence take?

If you’re considering buying an existing business, due diligence could range between a few weeks to a few months. It really depends on the size of the business and the complexity of the purchase.

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