When you are considering buying a business of any type, it is vital that you undertake due diligence. Due diligence should be thought of as a fact-finding process and will be used to make the final decision as to whether you proceed with the acquisition.
The purpose of due diligence is to ensure there are no unexpected problems or unforeseen liabilities waiting for you further down the line. It is the time to pinpoint and discuss any underlying risks with the seller that may influence your decision to purchase the business.
With any business, the size of the investment will determine how much time you should spend on due diligence, but if you are considering purchasing an online or e-commerce business, there will be some additional risks and perspectives to take into account. It’s important not to miss these, as they could prevent a costly mistake down the line.
In this article, we will discuss the additional steps of due diligence you should take for an online, internet, or e-commerce business and show you exactly how to get it right every time:
DISCLAIMER: While I am an experienced entrepreneur and have undertaken due diligence many times, I am not an attorney, CPA, or intermediary. You should consult your own professional advisors before making any decision. I do not make any warranty for the advice given.
Business Verification & Seller’s Background
Unsurprisingly, with the purchase of an online business, it is unlikely that there will be physical premises to view. Equally, it is rare for buyers and sellers to meet during the sale process. In this situation, it is easy to be fooled by well-designed websites and promises of profitability. In fact, the volatility of online businesses can make due diligence very challenging. Well designed websites, cutting edge eCommerce stores, and blogs with seemingly good metrics could quite easily have a lack of long term sustainability or could be easily copied by your competitors.
During due diligence, you should engage in comprehensive business verification and research the background of the seller. Are they a professional online business creator? If so, they may have sold similar businesses to other investors. Have they spent years investing their time into the success of the company? This is usually a good sign but it is important to check that you will be able to use the same skills and talents as the original owners. Finding a good business to buy is as much about you and your skillset as the business itself. Your due diligence should ensure that the seller has a company history, a decent reputation, and a legitimate audit trail for your peace of mind.
Financial verification is the process of auditing and reviewing key financial documentation for the business. This may include Profit and Loss (P&L) statements, bank account records, payment processing records, supplier invoices, and anything else you may feel necessary for the specific business you are buying. It is a key stage in both the due diligence and overall buying process.
It is important that you understand the real value of the business, whether it is already growing or seeing a decline in revenue. New entrepreneurs should generally avoid businesses with falling sales as they may require large amounts of experience, knowledge, and capital to recover. Experienced entrepreneurs may seek this additional challenge, giving them the opportunity to acquire a range of digital assets for low amounts of money.
Both the historic financial information and the year on year growth metric should be used to make your own price assessment of the business. Online businesses are more volatile and research must be done into their performance over time as one-off or random spikes in sales can skew the data. A great starting point, if the seller has not already done so, is to graph the historic financial data or view it directly from reports in Shopify, Stripe, Paypal, or other business assets.
You will need to look at audited financial statements, customer and supplier contracts, the value of stock held, sales reports, and monthly statistics to help with this.
In addition to this paperwork, you should request a live screen share with the seller to go through the back end of the website, any affiliate partnerships, and online banking portals, where available, in order to conduct a second stage of verification of the financials as well as authentication of ownership.
If you are thinking of buying an internet business, you should seriously consider how comfortable you are with the level of technical risk involved and whether it is a good fit for your skillset. You will need to be able to decide if the technology you will be using is the most suitable for what you are trying to achieve.
You will need to consider whether the existing technology is robust enough to cope with more visitors and sales as you grow your business. You should not put yourself in a position where a technical issue could jeopardize the continuity of business operations or potential growth. Do you have the experience to update and deal with any problems on your website, servers, payment processors, and other technologies you may be using? If not, you will need to factor in paying an expert to do it or ensure you have the ability to learn when the need arises. If you are looking for web experts to make one-off changes for a low price, check out Fiverr.
You should research your competitors, how their websites compare to yours, what technologies they use to support their business, whether they outrank you in search results for your main keywords. This information will help you decide where your business is currently placed in the market and what improvements you may need to make to grow your turnover. Can it cope efficiently with the visitors to the site? Is it easy for customers to make purchases? These are questions you will need to factor in as part of your decision making progress.
If the technology is not stable enough to operate effectively now or in the foreseeable future, you may want to factor in how much a technology upgrade would cost a few months down the line. If you are looking for reliable web hosting with 24/7 support, I would recommend BlueHost.
Website Traffic Analysis
When considering the purchase of an online business, you need to analyze the volume of traffic to the website and how it arrives. You will need to investigate whether it is organic, paid, or fake traffic. High percentages of organic traffic is ideal, however, paid traffic from ads is fine as long as the ad account and targeting information is included in the sale. The spend on ads should appear as a purchase in the seller’s business expenses. You should also check the return on ad spend (ROAS) to ensure these ads are profitable. You will need to consider whether the website is overly reliant on one particular traffic source and whether this is sustainable. If a business relies wholly on traffic from Facebook advertising, your profit margins would be greatly affected if ad prices were to increase.
You will also need to consider the value of the traffic on the website, such as the average time visitors spend on the site (session duration), bounce rate (the percentage of visitors to a particular website who navigate away from the site after viewing only one page) If the session duration is short (less than 2-3 minutes), it may mean the content is unattractive or difficult to navigate. You should also consider the loadtime of the website. You can check the loadtime of any website using Google’s official PageSpeed Insight tool.
If you are purchasing an online store or e-commerce business, you will need to consider the conversion rate and the return on ad spend of any paid advertising. As with all your analysis, a poor conversion rate should not lead you to discard the business entirely. It may be a weakness of the business or it may be a great opportunity for you to exploit. Potentially, the product or service you offer may not be appealing to your customers, alternatively, it may mean with some simple tweaks to the website, you could double or triple your profits. It is very important to inspect and analyze this closely.
Aside from the technical aspects of running an online business, you should consider and verify the time commitment required to manage the business successfully and meet your customers’ expectations. The seller should be able to break down the tasks and responsibilities and give a fair estimation of the number of hours required for the day to day running of the business to keep it operational plus the amount of time spent on planning promotions, ads, and future growth.
Consider the following:
- Customer support and returns
- Sourcing of new products
- Management of paid advertising
- Content marketing and sales
- Bookkeeping and finance
If you are purchasing a service-based business, you may also need to consider how the service will be provided. Will you be doing this yourself or outsourcing the work? Does the sale include the staff who have previously been providing the service?
By analyzing this information, you should be able to gain a good understanding of whether you have the time and skills to operate and grow the business.
Your due diligence should also take into account the legality of the business. You will need to look at any contracts, leases, and licenses required to run the business. If you are purchasing an eCommerce store, you will need to consider that different countries and regions have different laws and regulations. This is particularly important if you are planning on selling within the European Union. There are various requirements, both for the quality and safety of products as well as the use of customer data.
It is imperative that you ensure the product you are selling is not regulated unless you understand the subject well. Products that make health claims are regulated by the FDA and selling without authorization is a serious offense. When buying a regulated business, ensure you consult a specialist attorney.
You should also consider the legal aspects of operating the business itself. How will you declare the income on your tax return? Should you incorporate an LLC to protect you from lawsuits or unscrupulous customers? Do you need to register a DBA in order to use your brand name? Does the name of the business violate any federal trademarks?
These points of due diligence, likely the most challenging and boring to verify, are in fact some of the most important. Failure to perform these checks correctly could result in a major problem leading to a situation in which you are unable to operate and ultimately will have to close. Make every effort to ensure you are trading legally or you may find yourself losing the business along with your entire initial investment. If in doubt, consult an attorney.
This guide has given you a strong insight into how to correctly conduct due diligence for an online business. The acquisition of a new business or digital asset is exciting but taking the time to analyze and scrutinize the seller’s documentation will ensure you know the strengths, weaknesses, opportunities, and threats to the business. Be sure to combine your analysis with your own research when making your decision. Making a well-informed choice is the most important part of acquiring a new business as the time and capital you need to dedicate to the business will be defined by the research you do now.