Buying a Business in Colorado: A Due Diligence Checklist

If you are buying a business in Colorado, the asking price rests on the seller’s numbers, and your job before closing is to confirm those numbers yourself. This checklist covers the documents to request, what to test, the red flags that matter and the Colorado accounts to check, with an example of whether the business can carry the loan you will use to buy it.

What documents should you request?

Ask for these early, ideally as a condition in the letter of intent. A seller who is slow to produce them is telling you something.

• Federal and Colorado income tax returns for the last three to five years
• Profit and loss statements and balance sheets for the same years, plus year to date
• Bank and credit card statements for every business account
• The seller’s SDE or add-back schedule, with support for each item
• Sales by customer, so you can see how concentrated revenue is
• Payroll reports and quarterly payroll tax filings, and a list of employees and contractors
• Colorado and local sales tax returns
• Leases, loans, equipment lists and any customer or supplier contracts that transfer with the business

What should you test?

Do the tax returns, books and bank deposits agree?

Start by comparing revenue on the tax return with revenue in the books and with deposits in the bank for each year. Small differences have ordinary explanations, such as timing or a deposit transferred between accounts. Large or unexplained gaps do not. If a seller says real income is higher than the return shows because some cash “didn’t make it onto the books,” treat that income as worth nothing. You cannot borrow against it, and you would be paying for undocumented, unreported earnings.

Do the add-backs hold up?

Each add-back should be a cost that will genuinely disappear under your ownership. The seller’s own salary, a personal vehicle or family insurance run through the business are usually fair. Repairs that recur every year, a relative on payroll who does real work, or a “one-time” legal bill that appears every year are not. Ask for invoices and payroll records, and test each item.

What about working capital, customers and payroll?

Find out how much cash, inventory and receivables the business needs to run, and whether the deal leaves enough in place on day one. Look at customer concentration: if one customer is a quarter of revenue, the earnings depend on that relationship surviving the sale. Review payroll for workers paid as contractors who look like employees, and for late payroll tax deposits.

Which Colorado items should you check?

• Entity standing. Search the business on the Colorado Secretary of State business database. An entity that misses its periodic report moves from Good Standing to Noncompliant and then Delinquent, according to the Secretary of State. A delinquent status is fixable, but it tells you how the seller handles compliance.
• Sales tax account. Confirm the seller’s sales tax account with the Colorado Department of Revenue is current. The Department states that a retailer buying a business “assumes the liability for any sales taxes due, but not paid by the prior owner,” and that the buyer should withhold enough of the purchase money to cover them until the seller provides a tax status letter, which the seller requests on Form DR 0096. That guidance appears on Form DR 0155, which is also how a buyer reports sales tax on furniture, fixtures and equipment acquired with a retail business.
• Local sales tax. Some Colorado cities are home-rule jurisdictions that collect their own sales tax, and the Department of Revenue directs taxpayers to contact each jurisdiction directly. If the business sells in one of them, check that account too.
• Unemployment insurance account. The Colorado Department of Labor and Employment lists acquiring all or a substantial portion of a Colorado business from a liable employer as one way a buyer becomes liable for unemployment insurance premiums, per its employer FAQs. A successor that acquires substantially all of a business generally takes over the predecessor’s experience rating, which sets the premium rate. Ask for the seller’s current rate notice and premium reports.

Red flags worth slowing down for

• Revenue in the books that bank deposits cannot support
• Add-backs larger than a modest share of SDE, or add-backs that recur every year
• One customer or one contract carrying the business
• Unfiled or late sales tax or payroll tax returns
• A seller who cannot or will not produce bank statements
• Earnings that jump in the year before the sale

How does the tax structure of the deal work?

Most small-business purchases are structured as either an asset purchase or a purchase of the owner’s stock or membership interest. In an asset sale, the IRS treats each asset as sold separately, and both buyer and seller must use the residual method to allocate the price, according to the IRS. Each side generally reports that allocation on Form 8594, attached to its income tax return for the year of the sale. How much of the price goes to equipment, inventory or goodwill determines how quickly you can deduct what you paid, so negotiate the allocation, not only the price.

Can the business carry the loan?

Debt service coverage compares the cash the business produces with the payments on the loan. A coverage figure of 1.0 means every dollar of cash goes to the bank.

For example, a buyer looks at a Colorado business advertised with $300,000 of SDE and priced at $900,000. The buyer puts 10% down and borrows $810,000 over ten years at 10.5% interest, which works out to about $131,000 a year in payments. These figures are illustrative, not a lender’s terms.

	As advertised	After diligence
SDE	$300,000	$260,000
Less buyer’s salary	$90,000	$90,000
Less equipment reserve	$20,000	$20,000
Cash available for debt	$190,000	$150,000
Annual loan payments	$131,000	$131,000
Coverage	about 1.45	about 1.14

At the advertised numbers, the business covers the loan with a comfortable cushion. After $40,000 of add-backs fail, the cushion is about $19,000 a year, which one slow season can erase. Ask your lender what minimum coverage it requires, and use our debt service calculator to test your own numbers.

If you plan to use an SBA 7(a) loan, changes of ownership are an eligible use and the maximum loan amount is $5 million, according to the U.S. Small Business Administration.

A framework before you sign

Before you commit, write down four numbers: supportable SDE after testing the add-backs, the salary you need to live on, the annual loan payments, and the cash cushion left over. If you cannot fill in all four with documented figures, keep digging. Our business acquisition due diligence work does this testing for you, and an introductory call with our client services team is a good place to start.