What due diligence is actually for
The financials you evaluated in the previous stage were internally consistent. Internally consistent is not the same as true. A competent bookkeeper can produce management accounts that reconcile perfectly and still describe a business that does not exist. Due diligence is the work of testing that story against evidence the seller does not control.
Treated as a formality, it is money wasted. Done properly, it earns its cost several times over, because it changes three things about the deal.
Everything you find here has a destination. It is allocated in the purchase agreement, where each risk is assigned to a party and priced. A problem you uncover but do not carry into the agreement is a problem you have chosen to keep.
Financial verification: the numbers the seller cannot easily fake
Management accounts are the seller's version of events. Your task is to test them against records the seller does not control. The most powerful of these are the returns already filed with SARS, because a seller who inflates turnover for you would have to explain why they declared less to the Receiver, and few will put that admission in writing.
| Verify | Against | A gap means |
|---|---|---|
| Declared turnover | The VAT201 returns and the annual financial statements | Revenue shown to you but not to SARS, or the reverse |
| Payroll cost | The EMP201 declarations and the actual bank payments | Staff who are not on the books, or costs that will land on you |
| Cash actually received | Twelve months of bank statements, not a summary | Sales recorded that never arrived as money |
| Debtors | An age analysis, not a single total | A book full of old debt that will never be collected |
Ask for twelve months of bank statements directly from the bank, not a printout the seller has prepared, and reconcile the deposits against recorded sales month by month. Where recorded revenue runs ahead of money in the account, either the business is not collecting or the revenue is not real. Both become your problem the day after transfer.
The debtors' book deserves separate attention. A total tells you nothing. An age analysis tells you how much is current, how much is stretched beyond terms, and how much is old enough to be doubtful. A business can look profitable and be quietly drowning because a large part of its revenue is tied up in debt it cannot collect.
Then look at concentration. If a single customer is a large share of revenue, the business is more fragile than its profit suggests, and you need to know whether that customer is loyal to the business or to the owner who is leaving. That question is answered in the commercial review below, but the financial statements are where you first see the size of the risk.
Legal and compliance: the searches that surface what the seller left out
Financial verification tests what you were shown. Compliance work surfaces what you were not.
- CIPC status: confirm the company is registered, in good standing, not in business rescue or deregistration, and that its annual returns are up to date. A company deregistered for unfiled returns cannot contract, and reinstatement is slow.
- Tax compliance status: request a current tax clearance from SARS. A seller who cannot produce one is telling you about arrears they have not mentioned.
- Litigation and judgments: search for judgments and pending matters against the company and its directors. A clean set of accounts says nothing about a claim that has not yet reached the numbers.
- Licences and certificates: confirm every operating licence, health certificate and permit the business relies on, whether each is current, and whether it transfers to you or must be reapplied for.
- The lease: read it in full. Note the remaining term, the escalation, and above all whether the landlord may withhold consent to assignment. A business whose location is its value is worth far less if the lease will not move with it.
- Material contracts: read the agreements with key customers and suppliers for change-of-control and assignment clauses. A contract that lets the other party walk when ownership changes is a contract you may not actually be buying.
Licences and the lease are where asset purchases quietly lose their value, because these are the things that do not automatically come with the business. What can and cannot transfer is a legal question with commercial consequences, and it feeds directly into the structural decision on the purchase agreement page.
Employees: what you would be inheriting, before you decide how to handle it
The people are usually the least examined part of a purchase and often the most consequential. At this stage the work is investigative. You are building a complete and accurate picture, not yet deciding what to do with it. How a staff transfer actually works, and the protection you build against inherited employee liability, are dealt with on the purchase agreement page, where the law that governs it does its work.
Ask for the full schedule: every employee, their role, their start date, their current package, and their accrued leave. Accrued leave is a real liability with a rand value, and it travels with the business. Ask for any pending disciplinary matters or CCMA referrals, because a dispute in progress does not disappear when ownership changes. Then look hard at key-person dependence. If the business runs on the relationships or knowledge of one or two people, find out whether they intend to stay, whether anything binds them, and what happens to the business if they leave the month after you arrive.
Operational and commercial: whether the business works without its owner
The financials and the compliance file describe the business on paper. This part is about whether it functions, and whether it functions without the person selling it to you.
Start with the supplier relationships. Are the terms in writing, are they transferable, and does the business depend on a single supplier who could change those terms the moment the owner leaves? A favourable supplier arrangement that rests on a personal relationship is not an asset you can rely on inheriting.
Then the harder question, and the one that catches the most buyers. Are the customers loyal to the business, or to the owner? A business built on the founder's personal relationships is not the same asset as one customers use out of habit or need. This is what owner dependence does to value, and it is why so much of what you pay for can leave with the person you paid. Test it directly. Ask how sales are actually won, how much of the book the owner personally manages, and what the plan is for handing those relationships over.
Finally, look at the condition of what you are buying. Walk the premises. Check the age and state of the equipment and vehicles against the values in the accounts. A seller who stopped spending on maintenance in the year before a sale leaves the replacement bill for you, and the accounts will not show it until something breaks.
The seller question list: turning findings into answers on the record
Everything above produces questions. Putting them to the seller in writing does two things at once. It gets you answers, and it puts those answers on the record, where a false one stops being a misunderstanding and becomes a breach of warranty in the agreement that follows.
- Will you provide twelve months of bank statements directly from the bank, and confirm the accounts reconcile to declared turnover?
- Are all VAT201 and EMP201 returns filed and current, and will you provide a tax clearance certificate?
- Are there any disputes, claims or CCMA matters, pending or threatened, against the business or you as director?
- Which licences, permits and certificates does the business rely on, and which of them transfer to a new owner?
- Does the lease permit assignment, and has the landlord indicated whether consent will be given?
- Do any customer or supplier contracts contain change-of-control or assignment clauses?
- What proportion of revenue comes from your single largest customer, and is that relationship yours or the business's?
- Which staff are essential to the business continuing to trade, and what binds them to it?
Keep every answer in writing. The value of this list is not only the information it returns. It is that each written answer becomes something the seller has warranted, and something you can hold them to on the next page, where the questions you asked here become the protection you keep.
Where this leads
Due diligence tells you what is true. It does not, on its own, protect you. Protection comes from taking each thing you found and allocating it to a party in a contract that survives the seller's departure. That is the work of the next page.
Frequently asked questions
What documents should I request before buying a business?
Twelve months of bank statements obtained directly from the bank, VAT201 and EMP201 returns, a current tax clearance certificate, the full staff schedule with accrued leave, the lease, and any material customer or supplier contracts. The downloadable checklist on this page sets out the full list by category.
How far back should I check a seller's financials?
At least twelve months of bank statements, reconciled against recorded sales month by month, plus the VAT201 and EMP201 returns already filed with SARS. Filed returns matter more than management accounts, because a seller who inflated turnover for you would have to explain the same inflation to the Receiver.
What if the seller won't provide bank statements or a tax clearance certificate?
Treat the refusal as a finding in itself. A seller who cannot produce a tax clearance certificate is telling you about arrears they have not mentioned, and resistance to providing statements directly from the bank, rather than a summary they prepared, is one of the clearest signals due diligence can surface.
What red flags should due diligence uncover?
A gap between recorded revenue and the money actually reaching the bank account, a debtors book that is mostly old and uncollectable, licences or a lease that will not transfer to a new owner, and change-of-control clauses in contracts with the business's largest customers. Any one of these changes the price, or the deal itself.
Do I need an accountant or attorney for due diligence?
For anything beyond a very small purchase, yes. The findings from due diligence become the seller questions you put in writing, and those written answers become the warranties an attorney builds into the purchase agreement, so the two stages are connected rather than separate costs.