Due diligence is the part of an acquisition where the deal you think you are doing meets the deal that actually exists. For buyers, it is the chance to test every assumption underlying the purchase price. For sellers, it is the part of the process that often determines whether the closing happens on the agreed terms, or at all.
The process can feel exhausting from both sides, but it serves a critical function. A clean diligence process builds confidence and accelerates closing. A messy one creates risk premiums, escrow demands, and sometimes broken deals.
When Diligence Begins
Diligence formally begins after a letter of intent is signed and exclusivity is granted, but informal diligence often starts much earlier. Sophisticated buyers typically request high-level financial information, customer concentration data, and key contracts before they will commit to a price range. The deeper, document-by-document review begins once both sides have agreed on the framework of the deal.
The Major Workstreams
Financial Diligence
Financial diligence tests the historical performance of the business and the assumptions underlying the projections. Buyers typically engage an accounting firm to perform a quality of earnings analysis, which adjusts the reported earnings for one-time items, owner perquisites, and accounting irregularities. The number that emerges, often called adjusted EBITDA, is usually what the purchase price is actually based on.
Legal Diligence
Legal diligence covers the contracts, corporate records, intellectual property, employment matters, regulatory compliance, and litigation history of the target. The goal is to identify any liabilities that have not been disclosed, any obligations that may not transfer cleanly, and any rights the company depends on that are weaker than the buyer assumed.
Common findings include:
- Customer or vendor contracts with assignment restrictions or change-of-control provisions that require third-party consent
- Founder IP that was never properly assigned to the company
- Employee classification issues, particularly around independent contractors
- Open litigation, threatened claims, or compliance deficiencies that have not been disclosed
- Corporate records that are incomplete, missing minutes or stock issuances that should have been documented
Commercial Diligence
Commercial diligence examines the business itself: the customer base, the competitive position, the market dynamics, the team. Buyers want to understand whether the historical performance is repeatable and whether the projected growth is achievable. This is the part of diligence that most often produces price adjustments.
Tax Diligence
Tax diligence reviews the target's tax filings, payments, and exposures. It identifies any unpaid taxes, any positions taken that may be challenged, and any structural issues that could affect the buyer's tax treatment of the acquisition. For asset purchases, it also confirms the tax basis of the assets being acquired.
The deal you sign is rarely the deal you started negotiating. Diligence is the process that determines what changes, and a well-run process produces changes that reflect actual risk rather than negotiating leverage.
The Disclosure Schedule
Much of the legal diligence work culminates in the disclosure schedule, the document that accompanies the purchase agreement and lists the exceptions to the seller's representations and warranties. A well-prepared disclosure schedule protects the seller by carving out known issues from the buyer's claims for indemnification. A poorly prepared one creates room for disputes after closing.
Sellers often underestimate how much work goes into the disclosure schedule. Starting it early, before the diligence process is fully underway, is one of the highest-leverage moves a seller can make to keep the deal on schedule.
How Sellers Should Prepare
The best sellers begin preparing for diligence months before they go to market. That preparation typically includes:
- Cleaning up the corporate records, ensuring that minutes, stock ledgers, and consents are complete and current
- Confirming that all material contracts are in writing, signed, and accessible
- Resolving any open IP assignment issues, particularly with founders and key contractors
- Reviewing employee classifications and addressing any concerns proactively
- Engaging an accountant to perform a sell-side quality of earnings, which surfaces issues before the buyer's team finds them
This preparation costs money, but it produces a smoother process, a better price, and a faster close. Buyers reward sellers who are organized, and they discount the businesses that are not.
How Buyers Should Run It
On the buy side, the most important thing is to scope the diligence to the actual risks that matter. A scattershot review that produces hundreds of low-importance findings buries the real issues. A focused review that identifies the three or four findings that genuinely affect value gives the buyer the leverage to negotiate for them.
Diligence is also the buyer's first real exposure to the team they are inheriting. The way the seller responds to questions, the quality of the documentation, and the consistency of the answers all signal what life will look like after closing. Pay attention to those signals.
Whether you are on the buy side or the sell side of an acquisition, the diligence process deserves the same care as the negotiation that precedes it. We work with founders, executives, and investors to run diligence efficiently, identify the issues that actually matter, and bring deals to a close on terms that reflect what the parties really agreed to.
