Toronto business and franchise lawyer Sukhi Hansra, JD, MBA, of Hansra Law sets out a due diligence checklist scaled to a private Ontario acquisition, and a method for running it yourself.
Most due diligence checklists that you can find on the internet are great documents, but they are built for somebody else – namely, corporate development teams buying public companies, which is not applicable to the small business buyer. Another issue is that the most thorough checklists often sit behind a paid subscription.
If you are a person buying a small operating business, the public company checklists will often work against you. They are too long to ever finish, they point you at risks that a small company simply does not have, and they say nothing about the four Ontario searches that hold up closings in this province.
So here is a checklist scaled to a private acquisition, the Ontario items you need to add to the list, the continuity questions that no document request will answer, and a method for running the whole thing yourself before you spend money on advisors.
What belongs on a due diligence checklist
A due diligence checklist for a private acquisition covers eight categories: financial records, corporate records, commercial contracts, employees, assets and liens, real property, tax, and litigation and compliance. Each category asks the seller for a set of documents, and each one tests a single question about the business.
Eight categories is enough for almost any owner-operated company, provided that you also ask the continuity questions further down this page.
| Category | What to request | What you are testing |
|---|---|---|
| Financial records | Year-end statements for three to five years, interim statements, bank statements, receivables and payables aging | Whether the earnings you are buying are real and repeatable |
| Corporate records | Minute book, articles, shareholder register, director and shareholder resolutions | Whether the seller can actually sell what they are selling |
| Commercial contracts | Customer, supplier and distribution agreements, and any change-of-control terms | Whether the revenue survives a change of owner |
| Employees | Employment agreements, payroll register, contractor agreements, accrued vacation | What you inherit in wages, notice and termination exposure |
| Assets and liens | Equipment list, PPSA searches, equipment leases | Whether the assets are owned, leased, or pledged to someone else |
| Real property | The lease, all amendments, landlord consent and estoppel | Whether you keep the premises after closing |
| Tax | Corporate returns, HST filings, payroll remittance history, WSIB clearance | Whether an unpaid liability follows the business to you |
| Litigation and compliance | Claims history, licences, permits, regulatory correspondence | Whether a lawsuit or a lapsed licence arrives with the business |
On the financial line in particular, BDC is specific about the depth you should be asking for, recommending “accountant-prepared year-end financial statements for at least the past three to five years” along with details of any “ongoing, pending or threatened litigation”. The reason to ask for several years rather than one is that a single good year tells you nothing about whether the earnings repeat. None of this means you are hunting for a reason to walk away from the deal. You are testing one thing, which is whether the business you have been told about is the same business you are actually buying.
Take the checklist with you
The eight categories above, as a one-page checklist you can work through with the seller and hand to your accountant. It covers the Ontario searches most checklists leave off.
Free, and it is the same checklist we work from on real acquisitions.
The Ontario items most checklists leave off
Four Ontario items belong on your list and almost never appear on an American or British one: a PPSA search against the seller, a WSIB clearance certificate, the corporation’s minute book, and the landlord’s written consent to assign the lease. Each of the four can hold up a closing, and you can start all four yourself.
A PPSA search shows you what security has been registered against the business assets in Ontario’s personal property registry, and anyone can order one without a lawyer. This matters because a lender may already have registered a claim against the equipment you assumed you were buying free of debt. If that has happened, you want to find out while you can still renegotiate the price, not in the week you are supposed to close.
A WSIB clearance certificate shows you whether the business is current on its workplace insurance premiums. Ask for one dated close to your closing date rather than one the seller pulled last year, because the certificate only tells you about the account on the day it was issued.
The minute book matters most in a share purchase, because in that structure you are buying the corporation itself rather than a list of its assets. You are checking three things: whether the shares were properly issued, whether the directors were properly appointed, and whether the resolutions that should exist actually do. Minute books in owner-operated businesses are very often years out of date. That is a fixable problem, but it is only fixable before closing, because after closing it is your corporation and therefore your problem to clean up.
Landlord consent is the item buyers underestimate most, and it is worth explaining why. Most commercial leases require the landlord’s written consent before the lease can be assigned to you, or before control of the tenant corporation changes hands. In our own practice acting on business purchases, landlord consent is the item most often still outstanding when a buyer wants to close. Landlords run on their own timelines and they have no particular interest in yours, so the practical consequence is a closing that gets delayed or deferred until the landlord is ready to act. This is worse when the landlord is a large property management company than when it is a smaller individual landlord, because the request has to work its way through a process instead of landing on one person’s desk. So start that conversation in the week you sign your letter of intent, not once everything else is done.
The continuity questions no document request will answer
A document request tells you what the business owns and what it owes on paper. It does not tell you whether the business will keep running once the current owner has walked away from it, and answering that question is a separate investigation with a different set of questions behind it.
Four things decide it: where the customers come from, how concentrated they are, whether the staff stay, and what the owner actually does all week.
Where the customers actually come from. Marketing that runs on paid advertising transfers to you cleanly, because you can buy the same ads on the same platforms the day after closing. Marketing that runs on the seller’s personal referral network does not transfer cleanly, because those relationships belong to the seller personally rather than to the company you are buying. If most of the revenue arrives through the owner’s own contacts, then the sales engine walks out the door on closing day unless you do something about the handover. What you usually do is negotiate a post-closing transition period, where the seller stays on with the business for an agreed stretch of time for the specific purpose of introducing you to the referral sources and handing those relationships over deliberately. So ask how the last twenty customers found the business before you treat the marketing as an asset you are acquiring.
How concentrated the sales are. Ask what share of revenue the single largest customer represents, and then what share the top three represent together. If the bulk of sales comes from one customer, which is often the case in a business-to-business company, then that one relationship effectively is the business you are buying, and it deserves to be treated as the largest single risk in the transaction. Confirming it will continue after closing means three separate checks: whether there is a written contract at all, whether that contract contains a change-of-control clause that lets the customer walk when you take over, and whether anyone has actually asked the customer if they intend to stay.
Whether the staff stay. The employment section of a document request only tells you about contracts and liabilities, which is half the question. The other half is whether the people who make the business work will still be there in a year. Ask about tenure, about the experience each person actually holds, and about how likely they are to remain once the owner they were loyal to has gone. A long-serving employee who leaves three months after closing can take more value with them than any indemnity you negotiated will bring back, particularly where they hold the knowledge or the customer relationships that nobody wrote down.
What the owner actually does all week. This is the part of diligence that varies most from one business to the next, because the right questions depend on the industry, the market and the size of the company. The general questions are the ones a document list never thinks to ask. How does the work get divided among the team? Can the business run without the owner in it, or is the owner personally doing the work the customers are paying for? What would need to be hired for if they left? A managerial accounting analysis of the financial statements is usually what surfaces these questions, because reading the statements as management information rather than as a compliance filing turns up patterns in operations, trends and history that the documents alone will not show you. This is work we do with buyers directly, and it is the reason this firm is run by a lawyer who also holds an MBA. It is also where the most useful questions in a transaction tend to come from.
Your checklist changes with the deal structure
In a share purchase you buy the company along with its entire history, so your checklist has to reach backwards through old tax years, old contracts and former employees, all of which stay with the corporation after you own it.
In an asset purchase you buy a named list of assets instead, which narrows what you inherit but raises a different question, namely which of the things you actually want will transfer to you and on what terms.
Settle the structure early, because it decides how much of the work above you genuinely need to do. Our guide to asset purchase versus share purchase sets out how the two structures move liability between buyer and seller.
Employees are a good illustration of the difference being smaller than buyers expect it to be. A buyer of assets often assumes they are hiring a fresh workforce with a clean slate, and that the seller’s employment history is the seller’s problem. Ontario takes a different view. Under the Employment Standards Act, 2000, an employee’s length of employment with the seller of a business is “attributed, or ‘flows through’ to the purchaser of the business”, so the years someone spent working for the seller still count toward their entitlements with you. The one exception is narrow. Continuity does not apply where the employee is hired “more than 13 weeks after the employee’s last day of employment with the seller or the day of the sale, whichever is earlier.” So when you are pricing the workforce you are taking on, price in the years of service that come with them, because those years determine what a termination would cost you later.
How long to allow for it
BDC puts due diligence for a business acquisition at “six to 12 weeks or longer, depending on the complexity of the company and transaction.” Work backwards from that number rather than forwards from today, and check it against the exclusivity period in your letter of intent before you agree to one.
The arithmetic is what catches people out. Sixty days of exclusivity sounds generous right up until your accountant needs three weeks with the financial statements, the landlord takes a month to answer the consent request, and the seller’s bookkeeper is away for two of those weeks. Those delays overlap badly rather than politely queueing up. The underlying reason is that several items on your list sit with third parties who have no stake at all in your closing date.
How to run the checklist yourself
You can run most of this yourself before you hire anyone at all. Put every request into one numbered list, send that list once, record the date each item comes back, and keep a column for what is still outstanding.
That outstanding column is the real output of the exercise, because what a seller does not produce tells you considerably more than what they do.
- Build one list, not five emails. Number every item and group the items by the eight categories above. A seller who receives one organized list can sit down and work through it. A seller who receives a new question every second day starts treating you as a nuisance, and slows down accordingly.
- Send it with a date attached. Ask for everything by a specific day, and say which items you need first, so that your accountant can start the financial review while the rest is still being gathered.
- Log what arrives as it arrives. Four columns will do the job: item, date requested, date received, and notes.
- Chase the gaps weekly rather than at the end. A gap you find in week two is just a question you can ask. The same gap found in week eight is a delayed closing, because there is no longer time to resolve it.
- Read the non-answers, because they are answers. “We don’t really have that written down” tells you something about how the business is run. So does a financial statement the owner prepared instead of the accountant, and so does a major customer contract that turns out to be a handshake.
Two weeks before your exclusivity period expires, print the outstanding column on its own. That short list is your actual risk list for the transaction, and it is the document your lawyer should be working from rather than the full checklist.
One warning here is worth taking seriously, because it applies to careful buyers as much as careless ones. BDC notes that “some buyers make the mistake of dismissing information that challenges their enthusiasm about the transaction, only to regret it later.” Eight weeks into a deal you badly want it to work, and you have spent real money getting that far. That is precisely the point at which the awkward findings need the most attention rather than the least.
Where this becomes a legal question
Everything above is a business exercise. It becomes a legal one at the point where your findings have to land somewhere in the purchase agreement, because a problem you discover is only worth discovering if it changes something about the deal.
In practice it changes one of three things: the price you pay, a condition you attach to closing, or something the seller has to fix before you will close at all.
There is a fourth route, and it is the one that matters most after closing has happened. A finding can be handled by a representation in the agreement backed by an indemnity, provided that indemnity survives for long enough afterwards that you can still use it when the problem surfaces. That fourth route is where buyers who ran genuinely good diligence still manage to lose money. Finding an unpaid remittance or a customer contract that cannot be assigned is only half of the work, and the easier half. If the agreement does not then deal with what you found, you have simply paid to discover a problem and bought it anyway.
That gap is also why accepting whatever the seller hands over is such an expensive habit. A seller’s disclosure package is organized around what the seller wants you to see, whereas your checklist is organized around what you need to know before you commit. The gap between those two documents is exactly where your negotiating room sits, and you only find that gap by asking for things nobody offered you.
Although a checklist is a good starting point, every acquisition turns up something the list did not anticipate, and how that thing should be handled depends on facts a general article cannot know about your deal. A good next step is to speak with someone who has worked through it before, whether that is an Accountant or a Business Lawyer. Our guide to buying an existing business shows where diligence sits in the wider process, and our business sale and purchase page sets out how we work with buyers.
If you would like your diligence findings read against the draft agreement before you sign anything, schedule a complimentary discovery call with our firm, or reach the office at 416-580-0345.
This article is general business and legal information, not advice for your specific situation. What belongs on your due diligence list, and how a finding should be dealt with in your agreement, depends on the business you are buying and how the deal is structured. Speak with a lawyer about your own transaction before you sign a letter of intent.
