The Moment of Truth in Due Diligence
The letter of intent is signed. The price seems right. The buyer appears committed. Then due diligence begins, and everything you thought was settled becomes negotiable again. This is the moment where deals succeed or fail, where valuations hold or collapse, where years of building a business face their most rigorous examination.
Founders often underestimate what due diligence involves. It is not a formality to endure before closing. It is a systematic effort by the buyer to confirm that your business is what you claimed it was, and to identify any reasons why they should pay less, structure differently, or walk away entirely.
The Diligence Landscape Has Changed
Due diligence timelines have extended significantly. Industry analysis confirms that lower middle market transactions that closed in 45 days after LOI in 2021 now routinely require 60 to 90 days. The compression that characterised the overheated market has reversed. Buyers are taking longer and looking deeper.
This shift reflects several dynamics. Higher valuation expectations require more rigorous justification. Competitive tension has eased in many sectors, giving buyers time they did not have when deals moved faster. Lenders, particularly in sponsored transactions, demand more documentation before committing capital. The era of abbreviated diligence is over.
The scope has expanded as well. Deloitte's analysis of 1,500 dealmakers found that 88% of corporations and 81% of private equity firms have made shifts in their deal targeting strategies. This strategic realignment means buyers approach diligence with heightened focus on operational quality and business fundamentals.
What Buyers Actually Investigate
Due diligence encompasses multiple workstreams, each designed to validate specific aspects of your business and identify risks that affect valuation or deal structure.
Financial Due Diligence
The financial workstream anchors the entire process. Buyers and their advisors examine historical performance, validate reported metrics, and assess the sustainability of current results.
Quality of earnings analysis dominates this workstream. Buyers want to understand normalised EBITDA: what the business actually earns on a recurring, sustainable basis after stripping out one-time items, owner benefits, and non-operating expenses. The difference between reported and normalised earnings often surprises founders who have not prepared for this scrutiny.
Revenue quality receives particular attention for recurring revenue businesses. Buyers examine customer cohorts, churn patterns, expansion dynamics, and concentration risk. They model forward revenue under various scenarios, stress-testing the assumptions embedded in your projections.
Working capital analysis determines how much capital the buyer must leave in the business to fund normal operations. Disagreements about working capital targets are among the most common sources of post-LOI valuation adjustment.
Legal Due Diligence
Legal diligence examines your corporate structure, contracts, intellectual property, and litigation exposure. Buyers confirm that you own what you claim to own and that no undisclosed liabilities lurk in your agreements.
Contract review identifies change of control provisions, assignment restrictions, and termination rights that could affect the transaction. Material customer contracts receive the closest attention; a key customer with the right to terminate upon acquisition represents significant risk.
Intellectual property ownership, particularly for technology businesses, requires validation. Buyers confirm that employees and contractors have properly assigned their work product, that registrations are current, and that no third-party claims exist against your IP.
Operational Due Diligence
Operational diligence assesses whether the business can sustain its performance after the transaction closes. This workstream examines supply chains, key vendor relationships, operational processes, and technology infrastructure.
For software businesses, this includes technical diligence: code quality, architectural soundness, scalability constraints, and technical debt. Buyers want to understand what investment the technology requires to support continued growth.
Human Resources Due Diligence
People diligence identifies key employees, assesses retention risk, and evaluates the depth of the organisation. Buyers want to know whether the business depends excessively on specific individuals and what compensation or incentives might be necessary to retain them.
Employment compliance, benefits obligations, and historical HR issues also fall within this workstream. Undisclosed employment disputes or benefits liabilities can affect deal structure or valuation.
Cybersecurity Due Diligence
Cybersecurity has become a universal requirement. Current trends indicate that buyers now examine vulnerability management, monitoring capabilities, and attack response protocols regardless of business type. Supply chain security has become a particular focus, given recent high-profile breaches targeting vendor relationships.
For businesses that claim AI capabilities, additional investigation addresses proprietary versus licensed technology, model training data, data protection protocols, and output ownership rights.
How Diligence Findings Affect the Deal
Buyers rarely abandon transactions based on diligence findings. What they do instead is adjust terms: price, structure, or protections.
Price Adjustments
When diligence reveals that normalised EBITDA differs from reported EBITDA, or that revenue quality is weaker than presented, buyers recalculate their offers. A business marketed at $12M based on $2M EBITDA may trade at $10M if diligence normalises earnings to $1.7M.
These adjustments feel particularly painful because they come after a price seemed agreed. Founders should expect some adjustment as a normal part of the process, while preparing their businesses to minimise the gap between presented and validated performance.
Structural Changes
Diligence findings often drive structural modifications. Earnouts bridge gaps when buyers question revenue sustainability; if the business performs as claimed, the seller receives the full price, while the buyer is protected if performance falls short.
Holdbacks and escrows address specific identified risks. If diligence reveals a potential liability, a portion of the purchase price may be held back until that liability resolves or the risk period passes.
Seller financing sometimes emerges from diligence concerns. A buyer uncertain about post-close performance may ask the seller to finance a portion of the purchase price, aligning the seller's interest with successful transition.
Enhanced Protections
Diligence findings shape the representations and warranties in the purchase agreement. Issues identified during diligence become specific representations that the seller must make, with indemnification obligations if those representations prove false.
The broader trend favours buyers. Legal analysis confirms that the approach to addressing issues raised in due diligence has shifted toward more buyer-friendly protections, shaped largely by reduced competitive tension and wider valuation gaps.
Preparing for Diligence
The best diligence preparation happens before the process begins. Founders who address issues proactively position themselves better than those who react to buyer questions.
Conduct Pre-Sale Diligence
Consider engaging advisors to conduct sell-side diligence before marketing the business. A quality of earnings report prepared on your behalf identifies issues you can address before buyers discover them. Tax diligence confirms your positions are defensible. Legal review surfaces contract or IP issues that require remediation.
This preparation has costs, but the alternative is discovering problems during buyer diligence when your leverage is diminished and timelines are compressed.
Organise Your Documentation
A well-structured data room accelerates diligence and signals operational maturity. Buyers who find information quickly develop confidence in your organisation. Those who struggle to locate basic documents question what else might be missing.
Ensure documents are complete, current, and properly organised. Gaps and disorganisation extend timelines and create negative impressions that affect negotiations.
Prepare Your Team
Diligence involves your finance, legal, and operational teams. Ensure key people understand their roles, have time allocated for diligence support, and know what they can and cannot discuss with buyers.
Management presentations are a critical component of diligence. Buyers will meet your leadership team and form impressions that influence their confidence in the business. Prepare for these meetings as seriously as you would any high-stakes presentation.
Anticipate Issues
Every business has issues that will surface during diligence. Customer concentration, key person dependency, technical debt, contract limitations: whatever your specific challenges, assume buyers will find them.
Prepare explanations and, where possible, remediation plans. A founder who acknowledges challenges and presents thoughtful responses demonstrates credibility. One who seems surprised by problems in their own business raises questions about management awareness.
The Diligence Mindset
Approach diligence as a collaborative process rather than an adversarial one. Buyers are not trying to destroy your deal; they are trying to confirm that the deal makes sense. Help them reach that conclusion by being responsive, transparent, and prepared.
Responsiveness matters. Answer questions quickly and completely. Delays signal either disorganisation or reluctance to disclose, neither of which builds buyer confidence.
Transparency matters. Do not hide problems or obscure issues. Sophisticated buyers will find them eventually, and the discovery process damages trust far more than the underlying issue might have.
Preparation matters. The better prepared you are, the faster diligence proceeds and the fewer surprises emerge. Surprises during diligence almost never favour the seller.
The Outcome
Well-managed diligence processes conclude with buyers who feel confident in what they are acquiring. That confidence translates into transactions that close on schedule, with terms that reflect the agreed deal rather than progressive erosion through the diligence period.
Poorly managed processes produce the opposite: extended timelines, diminished trust, renegotiated terms, and sometimes failed transactions. The difference lies largely in preparation: sellers who invest in readiness before the process begins achieve better outcomes than those who react to the process as it unfolds.
If you are approaching a transaction and want to discuss diligence preparation, we would be glad to share our perspective.