Due Diligence Master Worksheet

Key takeaways

• Diligence is one job: confirm the story the seller tells is true, with documents, not assertions.
• The three lanes are financial (are the earnings real?), legal (any hidden liabilities?), and operational (does it run without the owner?).
• One serious red flag can be enough to walk: unverifiable revenue, a pending lawsuit, total owner-dependence.
• Diligence findings are negotiating currency: most discoveries reprice or restructure a deal rather than kill it.

The mindset: verification, not investigation theater

Every acquisition begins with a story: revenue is stable, customers are loyal, the equipment is fine, the owner is selling to retire. Diligence is the process of replacing that story with documents. Not because sellers are liars, since most are not, but because sellers are optimists about their own business, they forget inconvenient details, and the ones who are lying look identical to the ones who are not until you check.

The worksheet mentality matters because deal momentum is a drug. By the time diligence starts, you have imagined owning the business; every finding feels like an obstacle to a future you want. A written checklist with pass/fail criteria, agreed with yourself before you fell in love, is the antidote. It converts "how do I get comfortable with this" back into "is this true."

Scope diligence to the deal's size: a $150,000 service business does not need a Big Four quality-of-earnings report, but it needs the same questions answered at proportionate depth. The lanes below scale up and down; the discipline of documents-over-assertions does not change.

Lane one: financial — are the earnings real?

Everything starts with proof of cash. Reconcile the profit-and-loss statements to bank deposits and to filed tax returns for at least three years. The three sources should tell one story; where they diverge, the divergence is your first interview question. Sellers rarely overstate revenue to the IRS, which makes tax returns the conservative anchor.

Then attack the add-backs, the adjustments that convert reported profit into "seller's discretionary earnings." Legitimate ones (owner salary, personal vehicle, one-time lawsuit) are documented and defensible. The creative ones quietly inflate the earnings you are paying a multiple on: "one-time" expenses that recur every year, or a spouse's salary added back while the spouse does real work the buyer must replace. Every add-back is a claim; price only the ones that survive documentation.

Finish the lane with structure questions: revenue concentration (what share comes from the top one, three, and ten customers, and would they stay through an ownership change?), margin trend across years rather than the single flattering year, seasonality against your debt-service calendar, and working capital, meaning how much cash the business needs inside it to operate, which is capital you are buying or must inject.

Lane two: legal — what liabilities travel with the business?

The legal lane hunts for obligations that are invisible on a P&L. Liens: a UCC search shows whether the assets you are buying are already pledged as someone's collateral. Litigation: pending or threatened lawsuits, plus the pattern of past ones, since one lawsuit is life and a habit of them is a culture. Contracts: read the actual customer, supplier, and lease agreements for the two clauses that reshape deals. Assignability (can this contract transfer to you at all?) and change-of-control (does a sale let the counterparty renegotiate or walk?). A business whose best contract evaporates at closing is worth less than its P&L suggests.

Check licenses and permits: some transfer with a signature, some require requalification, and in licensed trades this can gate revenue for months. Check employees: classification (misclassified contractors are an inherited payroll-tax problem), key-person agreements, and any informal promises the team believes they have. Check taxes beyond income tax: sales tax nexus, payroll deposits, and unremitted obligations, which in some structures follow the business to its new owner.

The structural defense, beyond finding problems, is how the deal is papered: asset purchases (buying the assets, not the entity) leave many liabilities behind, while escrows, holdbacks, and indemnities make the seller financially answerable for surprises that surface later. This is exactly the terrain where a deal attorney earns their fee. General education here, not legal advice.

Lane three: operational — does it run without the owner?

The most common post-close disappointment is not fraud; it is discovering the business was the owner. The revenue was real. It was just attached to a person who left.

Interrogate owner-dependence concretely. Who do the top ten customers actually call, and have they ever dealt with anyone else? Who quotes jobs, who prices, who approves exceptions? What happens when the owner takes two weeks off, and has that ever even occurred? Is the operating knowledge written down anywhere, or does it live in one head? A business with systems, documented processes, and a second layer of capable staff earns its multiple. A business that is one person's relationships and judgment wearing an LLC is a job with goodwill: buyable, but priced and structured very differently, with a long transition and heavy seller alignment.

While you are in the building, verify the physical claims: equipment age and maintenance records against the "everything works great" story, inventory that is actually sellable rather than a decade of dead stock counted at cost, software and data that will survive the handoff. And meet the key employees late in the process. Their answers to "what would you change" are often the most honest diligence you will get.

Turning findings into decisions

Diligence findings sort into three piles. Deal-breakers: unverifiable core revenue, fraud signals, litigation that could swallow the company, a license you cannot get. These end deals, and the discipline is letting them: sunk diligence cost is not a reason to buy a problem. Repricers: real but bounded issues, such as a softer margin trend, equipment nearing replacement, or one heavy customer, which adjust price or terms rather than killing the deal. Structure items: risks you cannot fully resolve, handled with escrows, earnouts, seller notes, non-competes, and transition-support clauses that keep the seller invested in the outcome.

This is why diligence and negotiation are the same conversation, not sequential phases. Every verified finding is currency: "the top customer is 38% of revenue" converts naturally into "then part of the price rides on their renewal." Sellers who react to documented findings with rage rather than engagement are telling you something too.

Score each lane on the worksheet, resolve or structure every open item, and hold one rule sacred: any core claim that cannot be verified is a stop, not a discount. The scorecard below operationalizes the whole sequence. General education, not legal or financial advice.

Put it to work

Run every deal through the three lanes (financial, legal, operational) with documents required for every material claim. Sort findings into deal-breakers, repricers, and structure items, and let the worksheet (not deal momentum) make the call. Any unverifiable core claim is a stop until resolved. General education, not legal or financial advice.

Sources & references

Linked entries open the named source directly. Entries without a link say exactly what kind of reference they are — and how to check them yourself.

• U.S. Small Business Administration — Buy an existing business or franchise
• Due-diligence framework — The category checklist here (financial, legal, operational, customer) is the standard practitioner structure used across small-business M&A — a framework distilled from common practice, not one citable document.