The price of an SME is almost always based on a single figure: its profit, most often expressed as EBITDA. If this figure is overstated by $100,000 and the business is sold for four times its EBITDA, the buyer overpays by $400,000. They will pay this using their savings, a bank loan, and, often, a vendor take-back note that they will have to repay over several years.

Financial due diligence is used to confirm this figure before signing. It verifies that the revenues exist, that the expenses are complete, that the profit is recurring, that the business will be delivered with sufficient working capital, and that no debt is hidden on the balance sheet or in tax records.

This guide is intended for buyers acquiring an SME in Quebec, and for sellers who want to know what the buyer will examine. It focuses on the financial component. The legal, in-depth tax, operational, and marketing components are handled in parallel.

Summary answer: Financial due diligence verifies that the price is based on reliable figures. It is carried out in 9 steps: planning and requesting documents, assessing the reliability of financial statements, validating revenues, normalizing EBITDA, analyzing working capital, identifying debts and related items, verifying tax compliance and remittances, examining assets and off-balance-sheet commitments, and translating each finding into a price adjustment or contract clause. Allow 6 to 12 weeks for an SME.

What financial due diligence verifies, and what it does not

Financial due diligence is not an audit. It does not provide an opinion on the financial statements. It answers a buyer's questions:

• Is the profit on which the price is based real and sustainable?

• How much cash does the business require to operate?

• What debts, whether disclosed or not, is the buyer taking over?

• What could cost money after closing?

It does not replace legal due diligence (contracts, litigation, permits, intellectual property), which is the responsibility of a lawyer or notary. Nor does it replace commercial and marketing due diligence (clientele, competition, reputation, digital assets). For this component, see Marketing due diligence: the complete list before buying a business.

Share purchase or asset purchase: the scope changes

In a share purchase, the buyer takes over the entire company, with its entire history: its tax debts, future contributions, and litigation. The verification must go back far. In an asset purchase, the buyer chooses the assets they are taking over, and in principle, the debts remain with the seller. The verification then focuses on profitability, the assets purchased, and the charges encumbering them (mortgages, third-party rights). See Share sale or asset sale? Pros and cons.

Step 1: plan the verification and request the right documents

Timing

Due diligence begins after signing a letter of intent that sets the price, structure, and an exclusivity period. Before this stage, the seller generally shares summary information under a non-disclosure agreement. See When to have a potential buyer sign an NDA.

Plan for a sufficient exclusivity period: 60 to 90 days for an SME, depending on its complexity. Too short a period pushes the buyer to skip verifications. Too long a period ties up the seller.

The team

For an SME, the minimum team includes the buyer, a CPA familiar with transactions, and a lawyer or notary. The lender will also perform its own analysis, but that protects the bank, not the buyer. For a larger transaction, the buyer can commission a quality of earnings report from a specialized firm.

The document list

Request documents in writing using a numbered list and track the responses in a table. Documents must be deposited in a secure file-sharing space, never sent by email over the course of days.

BDC recommends examining at least three to five years of results, in addition to the current fiscal year. TRNSFR also offers a due diligence checklist and an acquisition preparation checklist.

Step 2: assess the reliability of financial statements

Before analyzing the figures, determine the level of confidence they deserve.

Compilation, review, or audit

Most Quebec SMEs produce financial statements compiled by a CPA. Since CSRS 4200 came into effect, the accompanying report is titled "compilation engagement report" (replacing the old "notice to reader"). A compilation offers no assurance: the CPA has formatted information provided by management without verifying it.

A review (review engagement) offers limited assurance, obtained primarily through inquiries and analytical procedures. An audit offers reasonable assurance, but it is rare in SMEs with less than a few million dollars in revenue.

Practical consequence: with compiled statements, it is the due diligence that does the validation work. Do not assume a figure is accurate just because it appears in a document prepared by a CPA.

Reconciling sources

A simple first test consists of reconciling sources that should match:

• profit from financial statements and income reported in tax returns;

• sales from financial statements and supplies reported in GST/QST returns;

• payroll and amounts from T4s and RL-1s;

• cash from the balance sheet and bank statements at the same date.

Discrepancies are not all problems (different fiscal year-end dates, tax-free or zero-rated sales, year-end adjustments), but each must be explained. To know what to look for in each statement, see Analyzing financial statements: keys to a successful acquisition.

Step 3: validate revenues

Revenues are the starting point for everything else. Three questions: do they exist, are they recorded in the correct period, and will they repeat?

Cash proof

Cash proof reconciles recorded sales with actual cash receipts. Start with sales, add taxes collected, adjust for changes in accounts receivable, and compare with total bank deposits. A significant discrepancy without explanation is a red flag.

In the restaurant and bar industry, Revenu Québec mandates mandatory billing via a certified sales recording system that communicates with MEV-WEB. Reports from this system are a valuable source: they allow for comparing recorded sales with accounted sales.

Example: the restaurant and "unreported sales"

A restaurateur in Trois-Rivières reports sales of $1,200,000 and an EBITDA of $150,000. In a meeting, he adds: "In reality, there is at least $100,000 more in cash per year."

The buyer must ignore this amount. They cannot verify it, they cannot present it to their bank, and if they buy the shares, they take on the risk of a tax assessment for previous years. The price must be based on reported revenues. And such a confidence should push the buyer to strengthen the seller's tax warranties, or even prefer an asset purchase.

Concentration and recurrence

Analyze sales by customer. If one customer accounts for more than 15% to 20% of sales, their loss after closing would change the business. Check if this customer is bound by a contract, if they have a personal relationship with the seller, and if that contract can be terminated in the event of a change of ownership. See Customer concentration and retention when buying a business.

Also distinguish between recurring revenues (maintenance contracts, subscriptions, regular customers) and one-time revenues (a big project, an exceptional order). Only the former justify a full multiple.

Year-end cutoff

A seller preparing for sale might, voluntarily or not, inflate the last year: billing work in December that is delivered in January, deferring expenses, reducing maintenance. Examine sales and expenses for the last few weeks before and the first few weeks after the fiscal year-end.

Step 4: normalize EBITDA

Normalization (also referred to as quality of earnings) consists of adjusting EBITDA so that it represents what the business will earn under the new owner, under normal conditions.

The seller usually presents an adjusted EBITDA that adds back personal or non-recurring expenses. This is legitimate. The buyer's work consists of verifying these adjustments and then looking for those the seller has not made, often on the downside.

The most frequent adjustments

• Owner's compensation: salary above or below market, or remuneration paid only in dividends. You must factor in the cost of a manager to do the work.

• Family members: salaries paid to relatives who do not work in the business, or who work there without being paid.

• Rent: the building often belongs to the seller. If the rent is below or above market, the new lease will change the EBITDA.

• Personal expenses: vehicles, travel, insurance, cell phones.

• Non-recurring items: legal fees for a settled dispute, gain on sale of equipment, one-time grant, major exceptional contract.

• Inventory: overvalued inventory at year-end inflates profit.

• Deferred maintenance: postponed repairs embellish recent results.

Numerical example: Usinage Beauce inc.

A machining workshop in Saint-Georges is offered at $2,900,000, which is four times an adjusted EBITDA of $725,000 according to the seller.

At the same multiple of four, the value drops from $2,900,000 to approximately $1,864,000. The gap exceeds $1,000,000. The two parties may not agree on every adjustment, but the negotiation is now based on verifiable facts, not impressions.

The TRNSFR EBITDA calculator allows you to redo the calculation. For choosing the multiple, see Business sale multiples in Quebec: a guide by industry and size.

Tip: document every adjustment with supporting evidence (invoice, lease, contract, pay statement). An adjustment without proof has no value to a bank.

Step 5: analyze working capital

Working capital is the money tied up in operations: accounts receivable and inventory, minus accounts payable and accrued expenses. It is often the blind spot for buyers.

Why it counts in the price

The price of a business assumes it is delivered with normal working capital, sufficient to operate without the buyer needing to inject cash the day after closing. A seller can, legally, aggressively collect their accounts receivable, reduce inventory, and stretch payables before the sale. They essentially withdraw cash that the buyer will have to replace.

The working capital target

The practice is to set a working capital target in the purchase agreement, usually based on the average of the last 12 months (to account for seasonality). At closing, the actual working capital is compared to the target and the price is adjusted, dollar for dollar.

Numerical example

A parts distribution company in Laval has an average working capital of $310,000 over 12 months. The agreement sets this target. At closing, the actual working capital is only $250,000: inventory has decreased and suppliers have not been paid for 60 days. The price is reduced by $60,000. If the working capital had been $340,000, the seller would have received $30,000 more.

What to analyze

• the age of accounts receivable: are accounts over 90 days collectible?

• inventory turnover, and obsolete or unsaleable stock;

• actual payment terms to suppliers;

• seasonality: a landscaping company does not have the same working capital in March as in October.

Step 6: identify debts and equivalent items

Most SME transactions are done on a "cash-free, debt-free" basis: the seller keeps the cash and pays off debts at closing, and the buyer pays for a debt-free business. Everything then depends on the definition of "debt."

Obvious debts

Bank loans, lines of credit, equipment lease-purchase contracts, shareholder loans, vendor take-back notes from previous acquisitions.

Items equivalent to debt, often forgotten

• accumulated and untaken vacation for employees;

• earned but unpaid bonuses and premiums;

• income taxes for the period preceding closing;

• deposits and advance payments received from customers for work yet to be done;

• unpaid rent or restoration work required by the lease;

• warranties on work already invoiced (construction, renovation);

• ongoing claims or litigation;

• equipment lease contracts with a near-certain purchase option.

Each of these items must either be paid by the seller at closing or deducted from the price. Negotiate their list in the agreement, not after.

RDPRM search

Perform a search in the Register of Personal and Movable Real Rights (RDPRM) in the name of the company and, if applicable, its owner. It reveals movable hypothecs, reservations of ownership, leasing contracts, and legal hypothecs published, notably by the government for amounts owed. For real estate, perform a search in the land register.

Step 7: verify tax compliance and remittances

In a share purchase, any tax debt of the company becomes the buyer's problem. In an asset purchase, debts in principle remain with the seller, but a published legal hypothec or certain specific rules (notably between related parties) can catch up with them.

What to verify

• Income tax: T2 (federal) and CO-17 (Quebec) returns filed, notices of assessment received, current or past audits.

• GST/QST: returns filed on time, balances paid, consistency with sales.

• Source deductions: monthly or quarterly remittances made on time, annual statements filed. Directors are personally liable for certain unremitted sums, which also concerns the seller.

• CNESST: employer account statement, contributions paid, work-related injury records that could increase the contribution rate.

• Other organizations: municipal taxes, construction commission for subject companies, annual permits and fees to the Registraire des entreprises.

How to obtain the information

Do not rely only on copies provided by the seller. Ask them to authorize your CPA to consult the files:

• at Revenu Québec, using form MR-69 (authorization for the communication of information or power of attorney);

• at the Canada Revenue Agency, using representation services (Represent a Client) or the authorization of a representative form provided for businesses.

The account statement obtained directly from the authorities is more reliable than a statement from the seller. It also shows outstanding balances and current notices.

Example

When buying the shares of a transport company in Abitibi, the buyer's CPA discovers, by consulting the file at Revenu Québec, that the company is under audit regarding its input tax credits for the past three years. The seller had not mentioned it, believing it "was nothing." The purchase agreement was amended to include a specific seller indemnity and a $75,000 holdback in trust until the audit was finished.

Step 8: examine assets and off-balance sheet engagements

Maintenance capital expenditures

EBITDA does not account for the investments required to keep the business operating. A transport company that must replace two trucks per year or a factory whose machines are 20 years old has an investment requirement that reduces the cash actually available to repay debt.

Compare investments from recent years to depreciation. If the company has invested much less than it has depreciated for several years, the equipment is aging and the buyer will inherit the bill. Have major equipment inspected by a competent person.

Engagements that do not appear on the balance sheet

Depending on the accounting standard used, several engagements do not appear on an SME's balance sheet:

• real estate and equipment leases (remaining term, renewal clauses, change of control clause);

• minimum purchase commitments to a supplier;

• guarantees or sureties given by the company for other companies owned by the owner;

• contracts with penalty clauses;

• commitments to employees (promised bonuses, severance pay provided in contracts).

These commitments are found in contracts, notes to financial statements, and the seller's answers to specific questions. Ask the seller to declare in writing any guarantee or surety given by the company. For related legal risks, see Managing legal risks in buying a business.

Step 9: turn findings into decisions

Due diligence with no consequence for the transaction is useless. Each significant finding must lead to one of the following decisions:

1. Reduce the price: when the finding changes normalized EBITDA or asset value.

2. Adjust a pricing mechanism: set the working capital target, define the list of debts, provide for a closing adjustment.

3. Require a specific seller representation and warranty: for example, that no tax debt exists beyond those disclosed.

4. Provide for a specific indemnity: for a known but uncertain risk (an ongoing tax audit, a dispute).

5. Provide for a holdback or right of set-off: a portion of the price kept in escrow, or the right to deduct claims from a sale price balance. See Sale price balance: definition and operation.

6. Change the structure: switch from a share purchase to an asset purchase when the company's past contains too many unknowns.

7. Withdraw: when discrepancies reveal a trust issue rather than a simple disagreement over the numbers.

To prepare for the subsequent negotiation, see TRNSFR's negotiation preparation checklist.

Complete example: what due diligence changed

Let's return to Usinage Beauce inc. The letter of intent provided for a price of $2,900,000 for the shares. After eight weeks of verification, the buyer presented their findings:

The seller accepted a lower price than hoped, but the transaction was completed. Without due diligence, the buyer would have overpaid by approximately $750,000, funded by a company that could not afford it.

Checklist: financial due diligence

☐ Signed letter of intent, with exclusivity period and access to documents

☐ Signed confidentiality agreement

☐ Team in place: CPA, lawyer or notary, and lender informed

☐ List of documents transmitted and tracked in a spreadsheet

☐ Type of financial statements determined (compilation, review, or audit)

☐ Financial statements reconciled with income tax returns, GST/QST filings, and payroll records

☐ Cash verification performed: sales reconciled with bank deposits

☐ Sales analyzed by client, product, and month; concentration evaluated

☐ Year-end cutoff examined

☐ Normalized EBITDA, with each adjustment supported by documentation

☐ Average working capital calculated over 12 months and target proposed

☐ List of debts and equivalent items established

☐ Searches in the RDPRM and, if applicable, the land register

☐ Revenu Québec, CRA, and CNESST files consulted with authorization

☐ Maintenance investments evaluated and major equipment inspected

☐ Leases, guarantees, sureties, and off-balance-sheet commitments identified

☐ Each finding translated into a price adjustment, clause, or closing condition

The most common pitfalls

• Relying on compiled statements. They offer no assurance. It is the due diligence that validates the numbers.

• Accepting the seller's adjustments without looking for those that go the other way. Executive salary and rent at market rates are the two most costly omissions.

• Paying for undeclared income. Income that cannot be proven is worthless, and it can be expensive.

• Forgetting working capital. Without a target in the agreement, the seller can legally drain the company of its liquidity before closing.

• Defining debt too narrowly. Vacation, bonuses, customer deposits, and accrued taxes are debts for the buyer.

• Settling for documents provided by the seller. Account statements from tax authorities and the CNESST must come from the source.

• Discovering problems without changing the contract. A finding that does not result in a clause or price adjustment protects no one.

• Lacking time. An exclusivity period that is too short pressures you to sign before finishing.

For other common mistakes, see The 5 most frequent mistakes during a business transfer in Quebec.

Can you conduct your own financial due diligence?

Partially. An acquirer who knows the sector can do a good portion of the work themselves: analyzing sales by client, spotting personal expenses, visiting facilities, speaking to key employees, and comparing results year-over-year. They know the operational reality they are buying better than anyone else.

However, engage a CPA for EBITDA normalization, working capital, debt definition, and tax compliance. These are technical issues, and the gap between a good and a bad analysis is often worth hundreds of thousands of dollars. The lawyer or notary will then translate the findings into representations, warranties, indemnities, and closing conditions. For a larger transaction, or if required by the lender, a quality of earnings report prepared by a specialized firm is a reasonable investment.

For the entire buyer's journey, consult The ultimate guide to buying a business.

Sources

• BDC, How to conduct due diligence when buying a business

• BDC, Due diligence checklist for buying a business

• Ordre des CPA du Québec, New compilation engagement standard (CSRS 4200)

• Revenu Québec, Transition to MEV-WEB – Restaurant sector

• Revenu Québec, Form MR-69 – Power of Attorney or Authorization to Communicate Information

• CNESST, Notice of Assessment and Statement of Account

• Register of Personal and Movable Real Rights (RDPRM)

This article provides general information and does not replace accounting, tax, or legal analysis tailored to your transaction.