Buy-Side Due Diligence: What to Check Before You Sign

Price is almost never what kills a deal. In the ones I have watched come apart, the number was agreed months earlier and both sides were still comfortable with it right up until something else surfaced: a customer contract that could not be assigned, a manager who was never going to stay, a lease with a change of control clause nobody had read.

The tax structuring is a separate exercise and I have set it out in buying a business in Canada: price allocation, the GST44 election, which of the seller’s history you inherit. This article is the other half, and it answers a narrower question than “is this a good business.”

Diligence exists to test two things. Are the earnings repeatable without the seller in the room, and does the thing producing those earnings actually transfer to you. Every request below serves one of those.

Quality of earnings, not audited statements

A review engagement or an audit tells you the statements were prepared properly. It does not tell you what the business earns under your ownership, which is the only number that matters to a buyer.

Work through the income statement line by line and ask what changes on day one. Owner compensation is usually the biggest adjustment, and it cuts both ways: an owner paying themselves nothing has understated the cost of running the business, and an owner paying themselves and two family members well above market has overstated it. Rent paid to a related landlord company is another. So is insurance placed through a brother-in-law, a vehicle on the books that goes home every night, and a one-time contract that will not repeat.

Deferred revenue is the line I check first in service businesses. Cash collected for work not yet delivered is a liability you are inheriting, and I have seen it sit in the revenue line for a full year. If you do not understand what the statements are telling you, start with reading your financial statements.

Then agree a working capital target in the letter of intent, not at closing. The seller will otherwise run down inventory, stop replacing equipment and lean on receivables collection for the three months before you take over, and you will buy an empty tank.

Revenue concentration and the contracts that carry it

Pull the customer list by revenue for three years. If one customer is more than a fifth of the business, you are not buying a company, you are buying a relationship, and you need to know whose relationship it is.

In an asset purchase, contracts generally have to be assigned, and an assignment that requires consent gives every one of those counterparties a chance to renegotiate with you at the worst possible moment. In a share purchase the contracts continue with the same corporation, which is one of the genuine advantages of buying shares, but a change of control clause can still trigger. Read for the clause, not for the structure.

The people question, which is mostly an Ontario employment question

Two rules surprise buyers.

First, on a sale of a business in Ontario, an employee’s service with the seller follows them to you. The Ministry’s guidance on continuity of employment is clear that length of employment is attributed to the purchaser, so a fifteen-year employee you terminate six months after closing is a fifteen-year termination, not a six-month one. The exception is a gap of more than 13 weeks between the employee’s last day with the seller and the day you hire them. Price that exposure before closing, because it will not appear anywhere on the balance sheet.

Second, the non-compete you are counting on may not exist. Ontario has prohibited non-compete agreements in employment contracts since 25 October 2021, with only two exceptions: executives, and a seller who becomes an employee of the buyer following the sale of a business operated as a sole proprietorship or a partnership. Buying the shares of a corporation does not fall inside that exception. Whether a particular restrictive covenant is enforceable is a question for a lawyer, and it should be asked before you rely on it in your model.

The registry and records check

This part is cheap and people skip it anyway.

Ask for the minute book and read it. A federal corporation is required to maintain articles, by-laws, shareholder and director minutes, a securities register and a register of individuals with significant control, as set out in Corporations Canada’s guidance on corporate records. If you are buying shares and the register of individuals with significant control has never been maintained, you are inheriting the non-compliance along with the shares. What a neglected minute book usually signals is broader: share issuances never documented, dividends declared verbally, a shareholder agreement everybody remembers differently. The mechanics are in the minute book and corporate registers.

Run the personal property security search in every province the business operates in, and search the corporate name for litigation. Ask whether any creditor has issued a demand, and whether any licensed insolvency trustee or receiver has ever been involved, which the Office of the Superintendent of Bankruptcy maintains public records of.

Larger transactions can also carry a notification obligation under the Competition Act before they may close. The thresholds are indexed and change, so confirm the current figures against the Competition Bureau’s guidance for business rather than a number in a blog post, and get counsel involved early if you are anywhere near them.

What to do when diligence finds something

Finding a problem is the point. The mistake is treating every finding as a reason to renegotiate the headline number, because a price cut is the weakest of the four tools available.

Diligence surfaces an issue.
│
├── Is it quantifiable today?
│      ├── Yes → Adjust the price, or fund it from the
│      │         working capital settlement. Clean.
│      └── No  → Continue below.
│
├── Is it contingent, and will it resolve in 12 to 24 months?
│      → Holdback or escrow, released when it clears.
│        Ties the seller to the outcome.
│
├── Is it a risk only the seller can speak to?
│      → Specific indemnity with its own cap and
│        survival period, separate from the general
│        representations.
│
└── Does it break one of your two core questions?
       (earnings not repeatable, or the asset does
        not transfer)
       → Walk. A discount on a business you cannot
         operate is still a business you cannot operate.

The first ninety days decide more than the negotiation did

The handover plan belongs in the agreement, with dates. Who introduces you to the top ten customers, in what week, and is the seller paid to be available after closing or are they on a beach.

Tell the staff early, in person, and in one meeting rather than as a rumour. Payroll continuity, benefits continuity and reporting lines are what they care about. Everything else can wait.

Keep the seller’s records. You will need them for the CRA years that remain open, and the retention rules are in record retention in Canada.

And write down, in the first month, what you thought you were buying. Twelve months in, that document is the only honest measure of whether the diligence was any good. If the same business is also somebody’s exit, the seller-side view is in what your business is actually worth and succession planning for Ottawa business owners.

If you have a letter of intent signed and diligence about to start, send me the financial statements, the customer revenue schedule and the draft agreement. I will tell you which adjustments the earnings will not survive and where the purchase price should be held back rather than paid. Get in touch.