Why Due Diligence is a Subjective Process Nobody Agrees On
Investors can have opposing buying criteria
Due diligence is the process by which an investor or entrepreneur investigates the inner workings and history of an online business, with the aim of understanding whether the business is a viable investment for them as an asset.
This is often confused with a process called vetting.
Vetting is a more objective process that reviews the legitimacy of a business by confirming the financials and asset ownership.
You can probably see why they get confused with each other, but while vetting is an absolute must when valuing and assessing an online business to see if as an asset it is actually salable, due diligence isn’t.
That said, it can be the most powerful tool a buyer has.
Using Due Diligence for Ultimate Acquisitions
When you’ve got your due diligence structure laid out in a repeatable process, you become much better at acquiring stellar online businesses.
You should list the fundamental qualities you look for in any online business.
Ideally, you should create a layered checklist system that looks something like the following.
Checklist #1 — The Five-Minute Qualifier
With this checklist, you want to make sure the business has the fundamental qualities that match your buying criteria.
This includes the business model, the niche, the list price, an overview of the history of earnings, and any other must-haves.
You’re looking at the earnings history to make sure that the business has earned consistently over the years and doesn’t seem to be fad-based or heavily seasonal.
The rest of the criteria in this list are based on your skills and resources. Which business model do you have direct or indirect experience with? How much capital do you have to invest? What business connections do you have? What expertise do you have?
This might be difficult for someone who doesn’t have any experience in online business.
We get first-time buyers who have migrated from real estate investing and are looking to test new assets. They might want a large online business for a certain price that is a leader in its niche and, for the most part, runs itself. This is especially true for high net worth individuals and angel investors.
Checklist #2 — The Deeper Dive
When you get to this stage, you’re happy with how the business looks and are considering it as a potential investment opportunity.
This list is more granular than checklist #1.
Think of this stage as when you go to view a house you’re interested in buying. It’s within your budget, in the location you want, and the right size. Now you’re checking out the rooms to see how well the house is built. This is essentially a risk assessment.
In online business, you’re looking at how many traffic sources the site/store has, whether the business makes all its money from one product or offer, how specific the niche is and whether there are opportunities to expand, and other “business health” categories.
One thing you should always look at is the traffic reports. If cash is the lifeblood of an online business, traffic is its heart. A site must be seeing good levels of consistent traffic to survive.
Checklist #3 — The Final Assessment
This is the serious consideration stage. You’re doing your final checks and thinking about how you can grow the asset or how it fits into your investment portfolio.
When they get to this stage, most buyers are asking the seller of the business about its history.
If you notice a dip in traffic or earnings some months in the financial history, you should ask the seller why this happened. Similarly, if there were periods of rapid growth, you should also ask about them.
You’ll get access to the business profit and loss statement (P&L), where you can assess the income and expenditure and ask about any discrepancies or why there are certain costs.
Finally, once you’re satisfied with the answers the seller gave you, it’s time to consider the growth opportunities.
Sometimes buyers do this at the start as they get excited about all the things they can do to grow the asset, but they have it backwards. You should only consider what you can do after the sale once you know the business can sustain itself as-is. This will ensure you have a good foundation to scale the asset.
It’s Different for Every Buyer
We’ve covered the fundamental assessment criteria that will likely be in nearly all buyer’s checklists, but each buyer will have a checklist that is drastically different from the next.
Each buyer is looking for something different. They have their own set of skills and resources that determine their preferences in a digital asset.
When conducting due diligence on a content site, a buyer will look at what search engine optimization (SEO) work has been done on the site, including the backlink profile, as well as the quality of the content, whether the site is hosting ads, among other factors.
These factors are not as important or are not applicable to an e-commerce store, where a buyer would look at everything around the inventory, including the shipping costs, the amount of stock on hand, and the product ordering schedule.
Even for the same business model, buyers can have opposing buying criteria.
Take the content site business model, for example. One buyer could want a healthy site growing steadily with few blips in the business history, whereas another buyer could be looking for a site that has been hit by a Google penalty and has declining traffic as a result. This is because they have the skills needed to fix the problem and grow the site back up, and they’ll get the site cheaper because of the decline in traffic.
The uniqueness of each buyer’s due diligence system isn’t just based on their current skills and resources; it’s also based on their goals.
With our experience of working with thousands of buyers over the years, we have found that most fit into one or two of six buyer personas.
One of the personas is Strategic Sally.
Sally is looking to build an online business empire, so she buys businesses that will help her other businesses grow. She might have an e-commerce store selling old books, so she buys a content site that has an audience interested in old books. With this site, she can send the audience to her e-commerce store and potentially explode her sales.
Another persona is Newbie Norm.
Norm is a buyer who has either never bought an online business before or has only bought a few. They have little to no experience in online business and want to test the waters and learn the game. Their goal is to find a cheap, reliable business that they can experiment with as they learn the craft of buying and selling online businesses to build massive wealth.
Everyone has a unique set of goals, skills, and resources, and thus your due diligence system will be unique, too.
How to Build Your Due Diligence System
There are many online resources that you can use to learn how to build your own system.
A good place to start is with our free, downloadable due diligence checklist. That will give you the fundamental criteria to add to your due diligence system and help you avoid purchasing risky online businesses.
The main thing you need to do is break down your skills and how they can be used to grow a digital asset; your resources, including your budget and connections; and your goals and what type of business would fit into those goals.
Hopefully, this article has provided you with a foundational understanding of how due diligence works and you can go off and do your own research on how to build your own system. But if you get really stuck, feel free to call one of our expert business analysts — they are more than happy to help.
