What are the red flags to look out for during due diligence?

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15

Reply by a searcher
in Miami, FL, USA

^redacted‌ thank you for the tag! During due diligence, investors should watch for red flags indicating potential issues with a business. These include inconsistent financial statements, poor cash flow, unclear financial records, high debt levels, legal issues, high employee turnover, customer concentration risks, declining market position, operational inefficiencies, inventory issues, unfavorable supplier terms, unrealistic financial projections, poor management, negative industry conditions, and a negative reputation among stakeholders. Identifying these issues can help investors avoid potential pitfalls in business acquisitions.

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Reply by an investor
from McGill University in San Diego, CA, USA

Thanks for the tag ^redacted‌. I think Zach hit on most of them. It usually isn't one thing per se, it's usually a collection of things... here are a couple of other considerations.
1. Seller honesty
2. Pending litigation
3. Questionable accounting practices / Poor Q of E
4. Regulatory/Environmental compliance concerns
5. Unfavorable contracts
6. High churn
7. Employees paid below market
8. Key man risk
9. Inability to interview clients/key employees
10. Material change in business conditions during diligence

Searchers should lean on their service providers/investors/lenders for counsel, and also have a due diligence scorecard ahead of submitting an LOI. In parallel, and this is important, should continue sourcing deals while under LOI. It's real hard to stay objective (but far easier when you have 2-3 opportunities in the funnel)

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