There are substantial differences in the due diligence process between small businesses and large corporations. Because small businesses have fewer assets and operations, their due diligence process tends to be more limited in scope. However, a more tailored approach and specialised knowledge is often required to effectively assess the unique qualities and potential risks of a small business.

In small business acquisitions, it is especially important to ask the question: “Do the accounts accurately reflect a typical year’s economic performance? Small businesses are typically not reporting entities or required to follow accounting standards and tend to keep accounts primarily for tax purposes, rather than as management tools. In addition to carefully reviewing financial statements and tax returns, PPR Capital gathers information from various sources, including contracts, customer interviews, employee surveys, input from the small business owner, industry experts, and public records, to gain a comprehensive understanding of the financial, operational, legal, and market risks faced by the business. The quality of earnings is evaluated by examining revenue recognition practices for timing issues, unreported revenue, or channel stuffing. Similarly, expense accounts such as cost of goods sold, owners and employees compensation, travel and entertainment, vehicle expenses, insurances, rent or lease costs, professional service fees and depreciation expense are reviewed for adherence to tax rules and to identify any mixing of business and private matters. The basis of valuation of material assets on the balance sheet, namely inventory, property, plant and equipment and ‘related’ assets (e.g. factory owned by family trust) is carefully considered. As with any due diligence process, it is crucial to examine off-balance sheet items, such as contingent liabilities, leases, and capital commitments, in order to evaluate their potential impact on the liquidity and solvency of the business in the future.

There are several steps that can be taken to identify potential risks more effectively when conducting small business due diligence. PPR Capital uses a risk assessment framework to systematically evaluate the various risks faced by small businesses in particular. A small business’s success can sometimes hinge on certain crucial factors or elements. These dependencies should be well understood, as they can leave the business vulnerable to disruptions or failures in the dependent element. Some examples of single point dependencies in small businesses might include:

• Dependence on a single supplier for a critical raw material or component
• Reliance on a single customer for a significant portion of revenue
• Dependence on a single key employee or manager for critical tasks or decision-making

Compared to large corporations, assessing the unique qualities and potential risks of a small business investment can be challenging and calls for a more specialised and intimate due diligence approach.