Due diligence

What it means

Due diligence is a systematic review of a company ahead of a purchase, an investment or a major transaction. The aim is not to find a reason to walk away but to know what is being bought - and to price and warrant accordingly.

It runs on three tracks. Financial tests the accounts, margin, receivables and payables; legal covers contracts, title and disputes; tax covers exposures from earlier periods still open to assessment.

Due diligence is not an audit of the financial statements. An auditor gives an opinion on whether the statements give a true picture; due diligence looks for risks and circumstances that affect the price and structure of the deal even when the statements show them correctly - dependence on a single customer, say, or on the owner in person.

How it works in practice

The sequence is settled: an NDA, then a letter of intent or a term sheet, and only then access to the data room. Opening the books before confidentiality is signed is a needless risk.

A seller should run the exercise on themselves before approaching a buyer. Unrecorded arrangements, missing member agreements or unsettled loans can be fixed in advance; during negotiation they only reduce the price.

When a client prepares for a sale, we assemble the accounting side of the data room: statements and tax returns for recent years, the sub-ledger of receivables and payables, a list of loans and of contracts with related parties. The buyer’s questions go into one list and are answered in writing, so it is clear what was disclosed.

What to watch out for

Most surprises sit in payroll and tax: agreements never closed, contributions miscalculated, missing transfer pricing documentation. These liabilities travel with the company and show up in the price as a holdback or a warranty.

The buyer will restate the figures its own way. It strips one-off income out of EBITDA and adds costs the company never had, such as a market salary for an owner who worked in the business unpaid. A seller who does not expect this is negotiating a price its own numbers cannot support.