Working through the due diligence process

Buying an online business is exciting. So exciting that it’s easy to get carried away and risk buying unwisely. The good news is that it’s easy to avoid that pitfall.

When you’re buying an online business, everyone advises you to ‘do the due diligence’. Of course you must, that’s obvious, but exactly how do you do it with an online business acquisition? Unlike real estate or bricks and mortar retail and service businesses, there’s usually very little property, equipment or inventory being acquired with the purchase. You are assessing predominantly non-physical assets – but that doesn’t mean they are too intangible to inspect, assess and value.

Depending on the complexity of the business and the size of the purchase transaction, this stage is likely to take at least two weeks and will probably be the longest part of the overall sale process. Patience and staying grounded in this phase will really pay off in the long run, and if you decide to go ahead with your acquisition then you can do so with the fullest confidence.

Where due diligence fits in

Due diligence is different from the buyer’s initial consideration of the business as an appealing target for acquisition, no matter how carefully that has been done. It is a thorough and methodical analysis.

The due diligence phase commences once you have made a purchase offer in a formal letter of interest and the offer has been accepted in principle by the seller. There will probably be some mutually agreed variations written into the final specific details of the sale contract as a result of what is discovered in the due diligence probing by the buyer.

This is unlikely to be because of any deceptive claims by the business owner. Rather, the buyer may discover some impediment to the transfer of software licensing, other third-party arrangements or credit card processing arrangements, just for example, which need to be addressed in the final Agreement.

Remember that before gaining access to all the details of the business financials and operational systems, including all the external agreements in place and the level of owner expertise and time needing to be invested on a continuing basis, the buyer will need to have paid a substantial deposit or even full settlement amount, as negotiated, which is refundable and held securely in escrow. This is because otherwise some parties claiming to be authentic prospective buyers are merely attempting to gain access to the business financials and processes.

So, now at this stage it’s time to work quickly and efficiently, but still highly systematically, through the due diligence process. Discussed below are the key aspects to consider.

Take qualified advice

If you have lots of experience in the area it will all seem straight-forward and intuitive. On the other hand if this is one of your first acquisitions, overall or in the particular niche, gain the assistance of a more experienced guide who can lead you through the more technical aspects. If this is a trusted colleague then that’s ideal. However, the services of paid buyers’ advocates/consultants are readily available and not all that expensive. Ensure that anyone guiding your due diligence and the decisions based on it have no vested interest in the sale going through. Be wary of advice from brokers who, no matter how ethical, have a vested interest in promoting the value of the business.

Traffic analysis

The seller’s claimed traffic statistics need to be verified. Genuine sellers will readily cooperate in providing access to Google Analytics (or equivalent) over the long term so that the buyer can ascertain how many visitors the site has, how long they stay, what they view and whether they generally view multiple pages. If they stay for a low duration (under one minute) then it may indicate that the content quality or the UX is low. If visitors generally traverse multiple pages then the content quality and the UX is indicated to be high. Check the conversion rates for whatever monetization strategies are in place, and most importantly look for any emerging trends. Cross-check the financials with the traffic. How much revenue is each unique visitor generating on average? Does this outcome correlate with what the business model predicates?

Be alert to the possibility of any paid traffic or sponsored links driving traffic to the business. That is not inherently bad, of course, but it is an expensive strategy and a significant problem if the expense has not been disclosed by the seller. Over-reliance on unsustainable traffic sources is actually the most common single concern encountered by new owners acquiring online businesses.

Financial records

Assessing the audited accounts of income and expenses for as long into the past as possible is essential. Ensure there are no hidden expenses, such as software licenses or other licensing and registration fees. Ascertain the investment of the current owner’s time and expertise and put a dollar amount on this if the owner is not being financially recorded as an ‘employee’ cost. Be highly alert to the costs of all outsourced work such as content writing and website maintenance and ensure these are being fully disclosed. Don’t rely only on previous years’ financial records. Be vigilant about what the income and expenses are right now. Look for any indications of plateauing or even downturn.

Get to know the seller

Your due diligence process can be a dream if you establish a good business relationship with the current owner. That doesn’t mean it will be a nightmare if you don’t, but certainly your due diligence won’t yield all the positive information that it potentially could.

In online business purchases it remains fairly unusual for the buyer to meet the seller or the seller’s agent in person; after all they may well be located worlds apart. However, it is good practice to establish the seller’s business profile, history and reputation. While somewhat subjective, using social media platforms such as LinkedIn provides a valuable means of background checking.  

An authentic seller will be confident in the business and will have genuine reasons for wanting to sell the business at the present time. The current owner will have a clear sense of how the business is performing and, just as importantly, trending. Additionally the vendor may well have ideas for the next stage development of the business which would be useful to the purchaser, even if the buyer decides not to follow that particular growth strategy pathway.

Sellers should always be open to detailed questions from a prospective buyer as a result of the due diligence process. It is sound, and increasingly common, practice for the seller or the seller’s agent to agree to a conference call discussion with the buyer, to respond to questions or concerns raised by the due diligence. It also enables alignment of the buyer’s and seller’s expectations of the transfer. No reasonable seller expects a buyer to part with hard-earned money just on the basis of the buyer’s enthusiasm and blind faith.   

Technical and other asset issues

Successful online businesses all rest on relatively sophisticated technical operations, with not only base platforms but also plugins and extensions. It is essential to audit these and ensure that every element of the platform has been paid for or licensed, and that these are to be transferred with the business. SaaS and software businesses, as well as e-Commerce sites, will be reliant on source codes and it is important to confirm that they are clean and also modifiable for the future.   

Other assets which must be transferred include all domain names, subscription lists, customer records, product images and all third-party contract and communication details.

Owner’s operational commitment

What time and effort commitment is being invested by the current owner and what is the cost value of this? The seller should be open and specific about the details of this investment. Is this within the buyer’s capacity of expertise and time availability to sustain, and if outsourced what will it cost?

Legal aspects

Obviously, it is essential to check that the seller legitimately owns the business, its domain names and the assets being transferred, including all third-party agreements. It is unlikely that a site which is legal and unrestricted in its source territory will be illegal or prohibitively restricted in other territories which the buyer considers targets for growth. However, it is always possible and should be checked.

After the due diligence period and before committing to the final Agreement to purchase, it is important that the purchase contract be checked by a qualified legal practitioner with particular experience in the online business environment.

It is important to ensure that the seller has entered into a non-compete agreement for a specified period of time, and that this agreement is enforceable.  

Final considerations

It’s vital to be ultra-careful that all trademarks, propriety branding and any third-party brand licensing agreements are fully transferring with the business acquisition. Ensure there are no undisclosed debts or unpaid liabilities of any kind. In this regard double-check that you have an overview of the refunds policy and the potential liabilities arising from customer claims and returns once you have assumed ownership.

It is always wise to build into the sale contract a holdback provision. This allows the buyer to retain a percentage of the final sale price, usually 10 to 20 percent, for 30 to 60 days after the transfer. The advantage of this is that unanticipated delayed costs which were not incurred by the new owner can be debited against the final payment. Additionally, the seller will be motivated to assist in the ironing out of any issues in the transition which could not reasonably have been anticipated by the buyer on the information available.

Provided the final payout funds are securely lodged in escrow, a reasonable and ethical seller is unlikely to resist this provision as part of the purchase agreement.

There can never be a 100% guarantee against an unfortunate purchase. However, following these clear due diligence steps will provide very strong protection against disappointment and any possibility of falling victim to deception.