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Establishing an audience is one of the biggest challenges of building an e-commerce business. But by operating your business on a massive platform like Amazon, it’s possible to tap into their existing audience and get your products in front of the people you want to reach. This is why Amazon FBA (Fulfillment by Amazon) businesses have become so popular among entrepreneurs and investors.
Although Amazon offers plenty of potential for third-party sellers, buying an FBA business comes with specific risks. It’s critical to conduct thorough due diligence before investing your hard-earned money into an FBA business.
This article provides a comprehensive checklist for conducting due diligence when buying an Amazon FBA business.
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Why Due Diligence is Crucial for Buying an Amazon FBA Business
Buying a regular e-commerce business involves risk (as is the case with any type of business). However, doing business on Amazon’s platform comes with its own set of risks and potential concerns.
For example, not only do you have to consider the typical aspects of any business (financials, operations, etc.), but you also need to understand Amazon’s policies and how they can affect your future success. You must ensure the business is not currently at risk for an account suspension or closure.
Additionally, most Amazon FBA businesses rely heavily on outside services such as freight forwarders and manufacturers. Conducting due diligence ensures that these partnerships are legitimate and will continue to operate effectively once the business is transferred to you.
Step 1: Financial Due Diligence
We’ll start by covering the financial aspects. Just like if you were acquiring any other type of online business, you need to make sure the financials are sound and that you can verify all the essential details the seller provides.
You’ll need to get the following items from the seller:
- Income statement
- Balance sheet
- Cash flow statement
- Accounts payable and receivable
Verify the numbers by cross-checking with:
- Bank statements
- Credit card statements
- Tax returns
Additionally, there are a few details unique to Amazon-based businesses. Ensure you get:
- Customer Shipment Sales Report
- Settlement Report
- FBA Customer Returns Report
- Inventory Data
These reports come from the Amazon Seller Central dashboard and provide crucial information about the business’s performance and trends.
Verifying the financial data can be difficult if the business’s accounting records are not in order. E-commerce businesses, including Amazon FBA, should use accrual-based accounting rather than cash-based accounting.
Accrual accounting records revenue and expenses as they are earned or incurred. Cash accounting records the actual inflow and outflow of cash as it occurs.
Accrual-basis accounting more accurately represents the business’s financial health, so make sure the records are organized correctly.
For example, if the business purchases $50,000 worth of inventory in one month and $0 the next month, cash-basis accounting would show a $50,000 expense for the first month and a $0 expense for the following month. This leads to financial statements that provide a distorted view of profit, which can alter valuations.
Accrual accounting calculates the cost of goods sold each month, giving a more accurate look at the costs and profit.
Performing due diligence on an FBA business that uses cash accounting is challenging, so you’ll want to verify that the seller uses accrual accounting.
Evaluating Financial Trends
In addition to verifying that the numbers match up, you need to review the seller’s performance over the past few years to evaluate trends.
Almost all e-commerce businesses have some level of seasonality, leading to peaks and valleys throughout the year. To see the level of seasonality and evaluate trends, you must look at multiple years of data.
For example, a drop in sales from August to September may be the result of lower demand after summer ends. To see the real trends of the business’s performance, you should evaluate year-over-year performance.
The business may have experienced high sales in December due to holiday shopping, but how does it compare to the previous December?
✅ Passing Grade: You can verify the seller’s financials by matching them up with third-party documentation like supplier invoices, Amazon reports, and bank statements. The business also shows healthy year-over-year trends.
❌ Failing Grade: You cannot verify the seller’s financial data due to poor accounting or potential inaccuracies. Or, year-over-year trends show that the business is headed downward.
Step 2: Product Due Diligence
When evaluating an Amazon FBA business, it’s essential to conduct due diligence on the products being sold. Are the products high quality? Will you be able to continue to sell them for the foreseeable future? Are the profit margins sufficient?
This step helps you understand the risks and opportunities associated with the products and may help you determine whether the business is worth the purchase price.
Trademarks and Patents
Does the business have any trademarks or patents for its products? If so, ensure they’re properly registered and transferable to you as the new owner.
If the business has no trademarks or patents, research if it’s necessary or beneficial for you to obtain them (the bar is high for getting a patent). Having trademarks and patents can help protect your business from competition and provide a competitive advantage.
Verifying that the business’s products don’t infringe on any existing trademarks or patents is also essential. You can search on the USPTO website and database. If there are any potential trademark or patent issues, you should consult a lawyer before proceeding with the business acquisition.
Vendor Contracts and Pricing
Review the terms of the contracts, including minimum order quantities, lead times, and payment terms. Additionally, it’s crucial to analyze the prices charged by manufacturers or suppliers.
Production Costs and Profit Margins of Each Product
Make sure you have a clear understanding of the production costs for each product. This information will be necessary when evaluating profit margins and creating a pricing strategy.
Product margins for Amazon FBA sellers vary and can be influenced by the product’s category, but 15-25% is typical. According to a survey conducted by JungleScout, only 19% of sellers reported profit margins above 25%.
Smaller profit margins leave less room for error or variation, so it’s essential to understand the costs and margins of each product before purchasing the business.
Freight costs can significantly impact the profitability of an Amazon FBA business. Of course, details like the product’s weight and size will have a big impact on freight costs.
Additionally, the method of shipping the product will drastically impact the cost. For example, if the seller currently uses air express or air freight, you may be able to reduce costs and increase profit by shipping via sea (although it will take longer to receive your inventory).
Best Sellers Rank of Each Product
Reviewing each product’s Best Sellers Rank (BSR) is important to understanding the product’s demand. The lower the number, the higher it ranks in terms of sales volume. The Best Sellers Rank is shown in the product information on each product’s listing.
Inspection of Customer Reviews
You can learn a lot about a product’s quality by reading customer reviews. This includes reviewing the number of positive and negative reviews and any recurring issues or complaints. Products should have a high average rating, and negative reviews should be responded to or addressed.
It’s equally important to check reviews to make sure the seller is not violating Amazon’s policies by manipulating reviews. Sellers cannot give free or discounted products in exchange for reviews, and they can’t incentivize reviews. They also cannot participate in fake reviews or other schemes.
Check the reviews for phrases like “in exchange for an honest review,” “free product,” and other similar wording.
Signs of review manipulation are a major red flag because it could lead to disciplinary action by Amazon.
David Davis, Founder and CEO of FBA Flip advises prospective buyers to look for an overabundance of 5-star reviews or products with a few 1-star reviews to make it look legit, with very few 2, 3, or 4-star reviews. He says, “Normally, legitimate reviews fall somewhere between the middle.”
Davis also recommends checking the profiles of the reviewers. He says, “Look into the reviewers themselves and make an assessment of them and other products they’ve reviewed. Fake reviewers’ profiles sometimes reflect their illegitimacy by having only outstanding or extremely negative reviews about specific products. There are tons of overseas companies selling reviews, and social media groups that organize reviewers, so it is extremely important to assess and piece together a full picture of the business. Reviews and sales normally should be on the same level. If one aspect seems to be dragging significantly behind the other, it may be a flag worth looking into.”
✅ Passing Grade: The products are high-quality and stable, and should continue to sell. Product costs, including freight, allow for a profit margin of at least 15%, preferably more. And the seller is not manipulating customer reviews.
❌ Failing Grade: The products are low-quality or you have concerns about their ability to sell in the future. Profit margins are less than 15%. Or, there are signs of review manipulation, which could lead to the seller’s account being suspended or closed.
Step 3: Amazon Account Health Due Diligence
When conducting due diligence on an Amazon FBA business, it’s essential to evaluate the account health of the seller. The last thing you want is to puchase a business, take over the seller’s account, and have it suspended or terminated because of something the previous owner did.
David Davis believes that account health is one of the most commonly overlooked aspects of an FBA business during the due diligence process. He says, “Oftentimes, less savvy Amazon buyers find themselves in an unflattering situation post-acquisition by not having gone through a thorough enough review process into how the account has operated in its operational life. The marks left from one owner have unfortunately impacted the new owner on many occasions.”
Note: Amazon’s terms state that seller accounts are generally not transferrable, but it’s common for seller accounts to be transferred when the business that controls the account has been sold to a new owner. If you have any questions or concerns, be sure to contact Amazon before moving forward.
Seller Account Health Rating
Amazon rates the health of each seller account, so you can easily check to see how the account is doing (you’ll need the seller to provide access to Seller Central to get this data).
From Seller Central, go to Performance > Account Health, and you’ll see the “Account Health Rating.” It should be in green; otherwise, there are issues that must be addressed. The number of violations will be listed, and those should be zeroes.
If the seller fulfills some orders, some stats will be listed under “Shipping Performance.” Amazon tracks this to ensure that orders are fulfilled and shipped promptly and accurately.
Any violations or other concerns should be a significant red flag, as the account could be at risk of action by Amazon.
Davis says, “Black-hat tactics, counterfeit/IP infringement product complaints, are just some of the issues that need to be vetted before acquiring any Amazon-based business. Account health is just as important as the financial benefits of an established account.”
Order Defect Rate
Analyzing the defect rate helps assess the quality of the products being sold and the health of the seller account. Amazon calculates and tracks Order Defect Rate (ODR) to evaluate sellers and their products. ODR is simply the percentage of orders that have been returned or canceled due to a defect in the product or service.
A high ODR can result in account suspension or termination, so it’s crucial to evaluate and ensure that it’s below the target set by Amazon. You can view the ODR in Seller Central by going to Performance > Account Health.
Amazon customers can provide seller feedback for any order. While product reviews are specific to a particular product, seller feedback is for the seller account as a whole, and seller feedback is not product-related.
Positive seller feedback shows that the previous owner maintained good customer relationships and provided excellent service. It also indicates that customers were happy with their experience.
You can view overall seller feedback in Seller Central by going to Performance > Feedback. You can also view it from the site’s front end by clicking the seller’s name where it says “sold by.”
Confirmation of Brand Registry
Brand registry provides Amazon sellers additional protection against counterfeit products and unauthorized sellers. It’s crucial to ensure that the seller has registered their brand and that the products sold are authentic and protected (as much as possible) from dishonest sellers.
✅ Passing Grade: The seller’s health rating is good (green), the order defect rate is below Amazon’s target, and the seller feedback is mostly positive. Since Amazon is responsible for fulfilling and shipping FBA orders, there shouldn’t be many issues or problems showing up in the seller feedback.
❌ Failing Grade: The seller’s health rating is poor (red), the order defect rate is over or very close to Amazon’s target, or the seller feedback shows poor customer service. All of these are significant issues that could negatively impact you if you buy the business.
Step 4: Operational Due Diligence
This step involves examining the business’s day-to-day activities to ensure everything runs smoothly and efficiently. Here are some key areas to focus on during operational due diligence.
Inventory management is one of the most critical aspects of an Amazon FBA business. How does the seller currently manage inventory and fulfillment? Is everything shipped from the manufacturer directly to an Amazon warehouse? Is it sent to a third-party warehouse and stored until needed? Is it sent directly to the seller?
Additionally, you’ll need to understand how inventory is tracked, when re-orders are placed, how much inventory is on hand, and the cost of that inventory.
Note: Inventory is typically not included in the selling price of most Amazon FBA businesses. Typically, the buyer will pay the seller for the inventory at cost at the time of the closing.
Lead times refer to the time it takes for a product to be produced, shipped, and delivered. Understanding lead times is crucial to ensure you can maintain adequate inventory levels and meet customer demand. If your products are out of stock, you’re not making any money.
Longer lead times mean you’ll need to order inventory sooner or larger quantities to avoid running out of stock. Shorter lead times allow you to hold less inventory.
Employee and Contractor Details
It’s also essential to review the details of any employees or contractors of the business. This includes understanding the roles and responsibilities of each employee, their compensation, and any contracts or agreements they have with the business. Of course, you’ll also need to know if the employees or contractors are open to continuing to work for the new business owner (you) after the transition.
Standard Operating Procedures
Standard Operating Procedures (SOPs) are documents that outline the processes and procedures the business uses for everyday operations. During due diligence, you should review these documents to ensure they’re comprehensive, up-to-date, and clear. SOPs should cover everything from inventory management to customer service to ensure the business runs smoothly.
If the business does not have SOPs, taking over the operations can be more difficult because you won’t know exactly what was being done by the previous owner. Although you can certainly change and improve procedures, SOPs help ease the workload in the first few months while you figure things out.
✅ Passing Grade: The business has SOPs and a clear inventory management process in place. Employee and contractor agreements are acceptable.
❌ Failing Grade: The business does not have an established process for inventory management, which can lead to out-of-stock products. SOPs are not in place or are insufficient. Or employee and contractor agreements are not sustainable. It’s possible to overcome any of these obstacles, but you need to be aware of what you’re taking on.
Step 5: Marketing Due Diligence
When conducting due diligence on an Amazon FBA business, evaluating the marketing strategies used to promote the products is crucial. Here are some key aspects to consider at this stage.
Conversion Rate of Each Product
The conversion rate shows how well the products perform and is an important metric. You can use tools like JungleScout or Helium 10 to get this data. If the conversion rate is low (the average product has a conversion rate of 10-15%), it may indicate that the product is not resonating with customers and needs improvement.
Product listings greatly impact conversion rates, revenue, and profit. Check each listing to see if it’s well-written, descriptive, and optimized for search. The titles and descriptions should include relevant keywords and clearly state the product’s features and benefits. You should also check if the listings comply with Amazon’s policies and guidelines.
Poor product listings may present opportunities for improvement, but it will also require more time and effort.
Product Photos & Videos
The product photos and videos are equally as important as the text in the listing. They should be high-quality, visually appealing, and showcase the product’s features and benefits. They should also comply with Amazon’s policies and guidelines. If the images and videos are not up to par, it will negatively impact the conversion rate.
Again, improving the photos and videos may increase conversion rates, but you must be willing to do the work or hire an expert to handle it.
You should evaluate the seller’s marketing strategies to promote the products. This includes email marketing, social media marketing, influencer marketing, and more.
Are these strategies effective in driving sales and increasing brand visibility? And are there any untapped opportunities for promotion that you can capitalize on?
Amazon offers pay-per-click (PPC) ad campaigns that many sellers use to increase the visibility of their products. It’s essential to review the ad campaigns and see how well they’re performing.
Are they generating a positive return on investment (ROI)? If not, what areas can be improved? Be sure to check the advertising budget to see how much is spent promoting each product.
Additionally, some sellers run PPC ads on Google or other platforms. If that’s the case, perform the same analysis on those ads.
✅ Passing Grade: Product listings are well written, and photos and videos are high-quality. The products’ conversion rates are acceptable or better. PPC ads produce a positive ROI, and other marketing methods seem to be effective.
❌ Failing Grade: Conversion rates are significantly below average (for example, 5% or less). The product listings are not well-written, optimized, or descriptive. Product photos or videos are low-quality and not enticing. PPC campaigns do not produce positive ROI.
Below-average listings or photos/videos may be okay if you’re willing to put in the time, effort, and expense to improve them. Improving the listings and visuals should positively impact conversion rates and ROI on PPC ads.
Step 6: Niche and Competitor Due Diligence
Now, it’s time to evaluate the niche and competitors thoroughly. This will help you understand the market size, trends, and competitive landscape, which are critical factors in determining the potential success of the business.
Market Size and Trends
Research the market size and trends of the business’s niche. Is it a growing or declining industry? What are the current and predicted sales figures? Understanding these factors will give you an idea of the potential for growth and profitability.
You should identify the top competitors and analyze their products, pricing, marketing, and customer reviews. This will help you understand what they’re doing well and where there may be opportunities for improvement.
What are the strengths and weaknesses of the business you’re evaluating compared to its competitors?
✅ Passing Grade: The niche or industry is growing or stable and not passed on a trend.
❌ Failing Grade: The niche or industry is declining or dependent on the popularity of a trend.
Step 7: Legal Due Diligence
Legal due diligence is crucial before buying any business. You’ll want to ensure that the business complies with all legal requirements and does not violate any intellectual property rights.
Some of the details you should check include:
- Pending lawsuits or threats of lawsuits
- Business licenses and permits
- Contracts and agreements
Check the agreements with manufacturers and suppliers to see if they provide any legal protection or insurance in case of a defective product or a legal claim related to one of their products.
If you have any concerns, be sure to seek the advice of an attorney.
✅ Passing Grade: There are no significant legal concerns, existing lawsuits, or credible threats of lawsuits.
❌ Failing Grade: The business is currently in a lawsuit, there have been credible threats of a lawsuit, or there are other significant legal concerns.
Final Thoughts on Due Diligence for Amazon FBA Businesses
Conducting due diligence before purchasing an Amazon FBA business is crucial to making a sound investment. It involves thoroughly evaluating all aspects of the business and the market in which it competes.
While it may seem daunting, especially for first-time buyers, taking your time and being thorough in your evaluation is essential. Remember, the goal is to make an informed decision and mitigate potential risks.
By following this due diligence guide, you can increase your chances of success.
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