Quick answer: Due diligence is the buyer’s verification of what the seller has said about the business. Buyers examine financial results, tax compliance, contracts, customers, operations, people, technology and legal standing, usually through a shared online data room. Sellers who gather and organize the records before the process begins answer requests faster, protect their price, and avoid the delays and renegotiation that incomplete preparation invites.
Key points
- Diligence tests every statement in the marketing materials. Anything that cannot be supported with a document is likely to be discounted.
- Financial diligence usually carries the most weight on price, because the earnings figure is multiplied by the valuation multiple.
- Sellers who assemble the data room before launching shorten the process and avoid the impression of disorganization.
- Control sensitive information. Customer-specific data and pricing are shared late, to the selected buyer, and often through restricted access.
What diligence is for
When a buyer signs a letter of intent, it has seen what the seller chose to show. Diligence is its chance to check. The buyer is asking three questions: is the business what it was described to be, are there liabilities or risks that were not mentioned, and does the earnings figure behind the price hold up. The answers decide whether the deal closes, at what price and on what terms.
Because buyers verify, the best preparation is to have the evidence ready. A seller who can produce a document for every claim in the information memorandum is in a stronger negotiating position than one who has to search. The overview of the sale process shows where this phase falls.
Financial and accounting
The financial review carries the most weight on price, because the earnings figure is multiplied by the valuation multiple.
- Annual financial statements for the last three to five years, and monthly statements for the current and prior year
- Tax returns for the same periods, reconciled to the financial statements
- A schedule of adjustments (add-backs and deductions) with supporting invoices and explanations
- Revenue and gross profit by customer, product and period
- Accounts receivable aging and accounts payable aging
- Inventory listings, with age and valuation method
- Monthly net working capital, supporting the discussion of the target (peg guide)
- Debt schedules, leases and other obligations
- Budget, forecast and a comparison of past forecasts with results
- Capital expenditure history and plans
Why buyers ask: to confirm the earnings, understand the cash conversion and find anything that behaves like debt.
Tax
- Federal, state and local returns and any correspondence with taxing authorities
- Sales and use tax filings and payroll tax filings
- Records of any audits, notices or open disputes
- Entity classification and ownership history
- Information on tax elections that affect the deal structure (asset vs. stock guide)
Why buyers ask: a buyer who acquires the entity inherits its tax history, so it wants to know of exposures.
Customers and revenue
- Top customer list with revenue, margin and tenure
- Contracts with major customers, including termination, pricing and assignment terms
- Pipeline, backlog and renewal data
- Pricing policies, discounts and rebates
- Customer complaints, warranty claims and returns
- Names of customers a buyer may wish to call, to be released only when appropriate
Why buyers ask: to test concentration, recurring revenue and the strength of relationships. The concentration guide explains the concern.
Operations and suppliers
- Description of operations, facilities, equipment and capacity
- Supplier list with spend, terms and dependency
- Supply agreements and any exclusivity commitments
- Quality systems, certifications and compliance records
- Insurance policies and loss history
- Property leases and any real estate owned
Why buyers ask: to understand whether the business can deliver, what it depends on and what the buyer will need to invest.
People
- Organization chart, roles, tenure and compensation of employees
- Employment agreements, non-competes and non-solicits
- Benefit plans, bonus and commission arrangements and any deferred compensation
- Independent contractor arrangements
- Policies, handbooks and records of any claims
- Dependence on specific individuals, including the owner (key-person guide)
Why buyers ask: people drive value and carry liabilities. They want to know who is essential and what is owed.
Legal and corporate
- Formation documents, ownership records and governing agreements
- Material contracts and any with change-of-control or assignment provisions
- Litigation, claims, settlements and regulatory matters
- Licenses and permits, and whether they transfer
- Intellectual property: trademarks, patents, domain names and software, with proof of ownership and assignments from contributors
- Environmental reports and compliance records where relevant
Why buyers ask: to confirm the seller owns what it is selling and that nothing blocks the transfer.
Technology and data
- Systems used, licenses and contracts with vendors
- Data security policies, incident history and compliance with applicable data rules
- Dependence on custom software or key technical staff
Why buyers ask: a system failure or breach after closing becomes the buyer’s problem.
Illustrative example: How an unsupported item reaches price
A seller includes $240,000 of one-time costs in its adjustments, but cannot produce invoices for more than $100,000 of them. At a 6.0x multiple, the unsupported $140,000 of adjustments is worth $840,000 of price. The buyer’s accountants remove it, and the seller’s credibility on the other adjustments is reduced as well. The figures are invented to show the effect and are not benchmarks.
How to prepare
- Build the data room before launch. Use a clear folder structure that mirrors the categories above, and name files consistently.
- Reconcile first. Financial statements, tax returns and the adjustment schedule should tell a consistent story.
- Flag the weak spots. Identify what a buyer will question and prepare the explanation.
- Assign one point of contact. Requests and answers should pass through one person, so that responses are consistent and tracked.
- Keep the business moving. Diligence is time-consuming, and the owner still has to run the company.
- Stage the release of sensitive data. Share customer-level information only when the buyer is committed, and consider limiting it to advisors.
Frequently asked questions
What is a data room?
A secure, organized online repository where the seller places documents for the buyer and its advisors to review. It is usually divided into folders by topic, with permissions that control who sees what, and it logs who opened which files. Buyers prefer rooms that are well indexed and complete.
When do buyers receive the full set of documents?
In stages. Early on, buyers see summary financials and the information memorandum. After a letter of intent, they receive the detailed records for confirmatory diligence. The most competitively sensitive data, such as customer names and pricing, is often released last, and sometimes to advisors only.
What if diligence finds a problem?
The effect depends on the problem and how it is handled. Issues the seller identified and explained earlier usually produce a smaller response than ones the buyer discovers itself. Typical outcomes are a price adjustment, a specific indemnity or escrow for the item, a condition to closing, or in serious cases a withdrawal.
Should I hire my own accountant to review the business first?
Many sellers commission their own financial review before going to market, sometimes called a sell-side quality of earnings review. It identifies the same issues a buyer’s accountants would find, while there is still time to fix or explain them. The quality of earnings guide explains the review.
Thinking about a sale or an acquisition?
The Impetus Group provides sell-side and buy-side M&A advisory, from preparation and buyer outreach to negotiation and closing. A transactional valuation is often the first step, scoped and priced separately.
Related guides
- Quality of Earnings Report: What It Is and What Buyers Test: A quality of earnings report tests whether a company’s reported profit is real and repeatable. See what buyers examine, how it affects price and how sellers prepare.
- Net Working Capital Peg: How the Working Capital Adjustment Works: The working capital peg sets the level of working capital a seller must leave in the business at closing. See how it is calculated, negotiated and adjusted.
- How an M&A Sale Process Works: Stages From Preparation to Closing: A step-by-step view of a sell-side M&A process: preparation, marketing, bids, the letter of intent, diligence, the purchase agreement and closing.
- How to Prepare for a Business Valuation: A Practical Checklist: What to gather and decide before a business valuation: financials, add-back support, customer data, owner role and liabilities, and why each matters to a buyer.
- EBITDA Add-Backs: What Buyers Accept and What They Reject: Learn which EBITDA add-backs buyers accept in a sale, which they reject, and how adjusted EBITDA changes enterprise value, with a worked illustration.
- How to Read a Letter of Intent: The Terms That Decide What You Receive: A plain-language guide to the letter of intent in a business sale: price, structure, working capital, exclusivity, diligence and the terms that move your proceeds.
- When to Sell Your Business: Signals, Timing and Readiness: How to judge when to sell: personal goals, business performance, buyer demand and readiness, with a scorecard and the alternatives to a full sale.
This guide is general education. It is not a valuation opinion, appraisal, investment advice, or legal or tax advice. How these guides are made.