Business acquisition due diligence: Buying a business can provide an opportunity to enter a new market, expand an existing operation or acquire an established customer base and revenue stream. But before signing an acquisition agreement, buyers need to understand what they are actually acquiring, and whether the business is worth the price being asked. This is where business acquisition due diligence and valuation become critical.

Unlike starting a business from scratch, acquiring an established business can provide immediate access to employees, customers, assets, systems, relationships and operating infrastructure.

But an established business can also come with obligations and risks that may not be immediately visible.

A company may appear profitable while carrying significant tax exposures. Its revenue may look impressive while being concentrated among a few customers. Its reported earnings may include one-off transactions. Its assets may require substantial investment. Or its contracts, employees, regulatory obligations and liabilities may create risks that materially affect the economics of the transaction.

This is why due diligence and business valuation should be central to any significant acquisition decision.

Due diligence helps the buyer understand the business, verify the information provided and identify potential risks. Valuation helps translate that information into an assessment of what the business may be worth.

Together, they provide a stronger basis for deciding whether to proceed, what price to pay and what terms should govern the transaction.

Understanding What You Are Buying

The first question a prospective buyer should ask is not simply:

“How much does the seller want?”

It should be:

“What exactly am I buying, and what risks and opportunities come with it?”

A business acquisition involves much more than reviewing a profit and loss statement.

The buyer needs to understand the quality of the earnings, sustainability of revenues, assets and liabilities, tax position, contractual obligations, customers and suppliers, employees, intellectual property and potential legal or regulatory issues.

In Kenya, acquisition transactions can involve the acquisition of shares, businesses or assets that result in a change of control. Depending on the circumstances, this can bring competition-law and merger-control considerations into the transaction. The Competition Authority of Kenya (CAK) identifies acquisitions of shares, interests and assets resulting in control as forms of merger transactions and provides guidelines and notification procedures for transactions falling within the applicable framework.

This makes it important to consider the transaction from more than a purely financial perspective.

The objective of business acquisition due diligence is to identify matters that could affect:

• The value of the business
• The sustainability of its earnings
• The risks assumed by the buyer
• The future performance of the business
• The buyer’s ability to operate the business successfully after completion
• The structure and terms of the transaction

A buyer should therefore seek to understand the business before deciding what it is worth.

Financial Due Diligence: Does the Business Really Make the Money It Claims?

Financial statements provide an important starting point for an acquisition.

They should not, however, be the only basis for the investment decision.

Financial due diligence examines how the reported financial performance has been generated and whether it is likely to continue.

This can involve reviewing:

• Historical financial statements
• Revenue trends
• Gross and operating margins
• Operating expenses
• Working capital
• Debt and borrowings
• Cash flows
• Capital expenditure
• Related-party transactions
• Quality of reported earnings
• Exceptional or non-recurring items

Consider a business that reports strong profits but is experiencing declining operating cash flows.

That situation deserves further investigation.

Similarly, reported profits may contain unusual income or transactions that are unlikely to recur after the acquisition.

The key distinction is therefore between reported earnings and sustainable earnings.

This distinction matters because the findings of financial due diligence can directly influence valuation.

If normalised earnings are materially lower than reported earnings, for example, the amount a buyer is willing to pay may also need to change.

The question is not merely:

“How profitable has this business been?”

It is:

“What level of performance can reasonably be sustained after the acquisition?”

Tax Due Diligence: Are You Inheriting Tax Risks?

Tax is another critical component of acquisition due diligence.

Before purchasing a company, a buyer should understand its historical tax compliance and whether there are outstanding, disputed or potential tax liabilities.

Depending on the business, this may include reviewing:

• Income tax
• VAT
• Withholding tax
• PAYE
• Tax filings and returns
• eTIMS compliance
• Tax audits
• Tax assessments
• Objections and appeals
• Ongoing tax disputes
• Potential historical exposures

A business may initially appear financially attractive but become considerably less attractive once previously unidentified tax exposures are factored into the transaction.

This leads to an important question:

Are you buying the business — or are you also taking on its historical tax problems?

The answer can influence the purchase price, transaction structure and protections included in the acquisition documents.

It may also determine whether certain conditions need to be satisfied before completion.

Tax due diligence should therefore not be treated as a compliance exercise that happens independently of the transaction.

It can directly influence the economics of the deal.

Business Valuation: What Is the Business Actually Worth?

Once the buyer has developed a clearer understanding of the underlying business, the next question is valuation.

The seller will naturally have an expectation of what the business is worth.

However, the asking price is not necessarily the same as economic value.

Business valuation can be approached using different methodologies depending on the nature of the business, the information available and the purpose of the valuation.

Common valuation approaches include:

Income Approach

The income approach considers the future economic benefits expected to be generated by the business and assesses their present value.

This approach can be particularly relevant where the business has relatively predictable future cash flows.

Market Approach

The market approach considers comparable companies, transactions or relevant valuation multiples to provide an indication of value.

The availability and quality of comparable market information can significantly influence the usefulness of this approach.

Asset-Based Approach

The asset-based approach considers the value of the underlying assets and liabilities of the business.

It may be particularly relevant for asset-intensive businesses or circumstances where the underlying asset base is a significant driver of value.

The appropriate methodology depends on factors such as:

• Industry
• Profitability
• Growth prospects
• Asset base
• Capital requirements
• Cash-flow profile
• Availability of comparable market information

For an acquisition, valuation is therefore not simply about producing one number.

It is about understanding what drives value and determining whether the expected future returns justify the price being considered.

Due Diligence and Valuation Should Work Together

One of the most important principles in an acquisition is that due diligence and valuation should not operate as completely separate exercises.

They should inform each other.

Consider a business being offered for KSh 200 million based on its historical profitability.

During financial due diligence, the buyer discovers that a significant portion of the reported earnings resulted from a one-off transaction.

The valuation may need to be reconsidered.

The same principle applies if due diligence identifies:

• Significant working-capital requirements
• Outstanding tax exposures
• High customer concentration
• Major contractual obligations
• Substantial future capital expenditure
• Unusual related-party arrangements
• Risks affecting future earnings

Each finding can potentially influence the buyer’s assessment of value.

This is the critical relationship:

Due diligence tells you what is happening inside the business.

Valuation helps translate those findings into an assessment of value.

A sound acquisition process therefore connects the two.

Share Purchase or Asset Purchase?

Another important consideration is how the acquisition should be structured.

A buyer may acquire the shares of a company, thereby taking control of the existing corporate entity.

Alternatively, the buyer may acquire specific assets or business operations.

The choice can have significant implications for:

• Liabilities assumed
• Tax treatment
• Regulatory requirements
• Contracts
• Employees
• Assets transferred
• Transaction costs
• Risk exposure
• Overall transaction structure

Under Kenya’s competition framework, a merger may arise where control is acquired over another business and can be achieved through mechanisms including the purchase or lease of shares or acquisition of assets.

The appropriate structure should therefore be considered carefully rather than selected simply because one option appears easier.

The commercial, financial, tax, legal and regulatory implications should all be considered before the transaction is finalised

What Happens When Due Diligence Finds a Problem?

Finding a problem does not necessarily mean that the transaction should be abandoned.

In many cases, the finding should inform the transaction.

For example, an identified tax liability could potentially result in:

• A reduction in the purchase price
• An indemnity from the seller
• An escrow arrangement
• A condition that must be satisfied before completion
• A restructuring of the transaction

Similarly, concerns regarding the sustainability of earnings could affect the valuation or lead to mechanisms such as an earn-out arrangement, depending on the circumstances.

This illustrates an important purpose of due diligence.

It is not simply designed to identify reasons not to buy.

It provides information that allows the buyer to determine:

Whether to proceed.

What to pay.

How to structure the transaction.

And what protections should be negotiated.

The Real Question Is Not “Can I Afford the Business?”

Prospective buyers often focus on whether they can finance the purchase price.

A more important question is:

“Does the business justify the price I am paying, and what return can I reasonably expect from the investment?”

Answering that question requires consideration of more than the headline purchase price.

The buyer may need to consider:

• Expected future cash flows
• Growth prospects
• Financing costs
• Integration costs
• Working-capital requirements
• Capital expenditure
• Operational risks
• Potential liabilities
• Expected investor returns

A business that appears expensive may still be attractive if it has strong and sustainable growth prospects.

Conversely, a business that appears inexpensive may ultimately prove costly if the buyer inherits significant liabilities or discovers that its historical earnings cannot be sustained.

Price tells you what you are paying.

Value helps you understand what you are getting.

Buying a Business Requires More Than a Price

An acquisition is ultimately an investment decision.

The buyer needs to understand the business, verify the information provided by the seller, identify potential risks, establish an appropriate valuation and determine whether the transaction makes strategic and financial sense.

This is why the acquisition process should move beyond the question:

“The seller wants KSh X. Can we pay it?”

The more useful question is:

“Based on the financial performance, future prospects, risks and opportunities of this business, what is it worth to us — and on what terms should we acquire it?”

That shift in perspective can fundamentally change how an acquisition is evaluated and negotiated.

A Better Way to Approach Business Acquisitions

A well-considered acquisition brings together several disciplines.

Due diligence provides evidence about the business.

Valuation provides a financial perspective on its worth.

Tax analysis helps identify historical and potential exposures.

Transaction structuring provides a framework for addressing identified risks.

Commercial and strategic analysis helps determine whether the acquisition supports the buyer’s broader objectives.

Together, these processes help transform an acquisition from a transaction based primarily on expectations into a decision informed by evidence.

For business owners considering a sale, investors looking to acquire a company, or organisations exploring mergers and strategic acquisitions, obtaining independent financial, tax and valuation advice before entering into a transaction can help identify risks early, support informed negotiations and protect value.

Before you sign the deal, make sure you understand the business behind the price.

Ronalds LLP
Locally Independent. Globally Strong.

Frequently Asked Questions About Buying a Business

What is business acquisition due diligence?

Business acquisition due diligence is the process of investigating and evaluating a target business before completing an acquisition. It can cover financial, tax, legal, commercial, operational, regulatory and other areas to help the buyer understand the business and identify potential risks.

Why is due diligence important when buying a business?

Due diligence helps a buyer verify information provided by the seller, identify liabilities and risks, assess the sustainability of earnings and determine whether the proposed transaction makes strategic and financial sense.

How is a business valued before acquisition?

A business can be valued using approaches such as the income approach, market approach and asset-based approach. The appropriate method depends on factors including the business model, profitability, assets, growth prospects, capital requirements and availability of comparable information.

What is the difference between due diligence and valuation?

Due diligence focuses on understanding and verifying the underlying business, while valuation uses financial and commercial information to assess what the business may be worth. The two processes should inform each other during an acquisition.

What tax issues should be reviewed before buying a business in Kenya?

Depending on the business, tax due diligence may consider income tax, VAT, PAYE, withholding tax, eTIMS compliance, historical filings, audits, assessments, objections, appeals and ongoing disputes.

Is a low purchase price always a good acquisition?

No. A low purchase price may reflect risks, weak earnings, liabilities, capital requirements or other issues affecting the business. The key consideration is whether the expected future returns justify the price and risks associated with the investment.

Should I buy the shares or assets of a business?

The appropriate structure depends on the specific transaction. A share purchase and an asset purchase can have different implications for liabilities, tax, contracts, regulatory requirements and risk. The structure should therefore be assessed as part of the broader transaction process.

Final Thoughts

Buying a business is not simply about agreeing on a number.

It is about understanding the business behind that number.

Before committing capital, buyers should seek to establish:

What is the business really earning?

What liabilities and risks exist?

How sustainable is its performance?

What is the business actually worth?

What structure best supports the transaction?

And what terms are necessary to protect the investment?

The answers can make the difference between simply completing an acquisition and making a well-informed investment decision.

Written By Abdi Razaq