When a buyer evaluates a business for acquisition, due diligence is their roadmap to understanding what they’re really buying. It’s a critical process that helps them determine whether the deal moves forward, gets repriced, or falls apart entirely.
For sellers, understanding what buyers scrutinize and preparing accordingly can mean the difference between a smooth transaction and a deal-killing surprise. One key to success? Early preparation.
Early preparation helps enhance your company’s credibility, speeds up negotiations, and can even improve your final valuation. This article will explore due diligence from the buyer’s perspective and discuss how the sellers can prepare their business early to maximize deal success.
Planning to sell your business? The team at Acquinox Advisors can help you become diligence-ready and position your company for the strongest possible transaction.
What Buyers Really Look For During Due Diligence
Due diligence is a buyer’s systematic review of every aspect of the business they’re looking to acquire. The most common primary objectives of due diligence are reducing risk, validating growth prospects, and attempting to maximize their return on investment (ROI). Buyers are typically trying to answer three questions:
- What am I actually buying?
- What could go wrong?
- Will this investment generate the returns I expect?
Every document reviewed, every interview conducted, and every financial statement analyzed helps answer these core questions.
When buyers conduct due diligence, they’re looking beyond the polished sales pitch to understand the genuine operational reality of the business. They want to verify that financial projections are achievable, assets are properly owned and protected, and that there are no hidden liabilities waiting to surface after closing.
Due diligence is especially important in unique situations, like large transactions or cross-border deals.
Six Core Areas of Due Diligence
Comprehensive due diligence typically covers six major areas, each revealing different aspects of the business’s health and viability.
1. Financial
The most common starting point is the target company’s financial statements. Namely, the income statement, balance sheet, and cash flow statement, as well all detailed analytical data on which they are based.
During this process, buyers are looking for consistent, accurate reporting and sustainable profitability. Red flags include unexplained revenue fluctuations, irregular accounting practices, or discrepancies between reported figures and actual performance.
2. Legal
Another common area of due diligence is a complete legal review. This typically involves reviewing contracts, corporate documents, litigation history, regulatory compliance, and intellectual property ownership.
Buyers want to ensure there are no major legal issues that could hurt the company’s profitability, like pending lawsuits, unresolved disputes, or compliance violations.
3. Tax
Buyers will also loop in tax advisors to review the target company’s tax filings, obligations, and potential exposures. The goal here is to confirm that taxes have been paid correctly and that there are no tax risks that could impact the transaction structure or post-acquisition operations.
4. Human Resources
Buyers also assess the target company’s workforce, employment contracts, benefit plans, compensation structures, and any potential labor issues. Issues like high employee turnover rates, weak retention of key personnel, or unresolved workplace conflicts can signal deeper organizational problems.
5. Commercial
This step includes a high-level overview of the target company’s position in the market. The commercial review typically includes an analysis of the business model, market position, customer relationships, competitive landscape, and growth potential.
Buyers analyze details like whether the customer base is diversified or concentrated, whether the company’s market is growing or declining, and how the company stacks up against competitors.
6. IT and Operational
Finally, buyers will evaluate the target company’s technology infrastructure, cybersecurity practices, and operational processes. Outdated systems, cybersecurity vulnerabilities, or over-reliance on specific vendors can create integration challenges and hidden costs for buyers.
Most Common Deal-Breaking Red Flags
Certain issues consistently derail M&A deals. Understanding the most common red flags for buyers can help sellers address them proactively before the negotiations start. Here are the most common issues to be aware of:
- Owner Dependency: When a business relies too heavily on the owner’s personal relationships, expertise, or daily involvement, buyers worry about continuity post-acquisition.
- Poor or Incomplete Records: Missing financial documentation, disorganized files, or inconsistent record-keeping can suggest weak controls and make accurate valuation nearly impossible.
- Declining Revenue or Profitability: Negative trends in core business metrics raise serious questions about the company’s future performance and growth potential.
- Customer Concentration: If a large percentage of revenue comes from just a few customers, losing even one could devastate the business.
- Weak or Missing Contracts: Verbal agreements, expired contracts, or unfavorable terms with key customers and suppliers create uncertainty and risk.
- Legal or Compliance Issues: Ongoing litigation, regulatory violations, or unprotected intellectual property can halt deals immediately or significantly reduce valuation.
- Undisclosed Liabilities: Hidden debts, pending lawsuits, or off-balance-sheet obligations discovered late in due diligence destroy trust and often kill deals.
Early Due Diligence Boosts Credibility & Valuation
One of the most effective ways to prepare for buyer scrutiny is to conduct your own due diligence prior to taking your business to market.
Internal due diligence is a proactive assessment where you hire independent advisors to evaluate your business the same way a buyer would. Another option is to use an AI valuation tool to get a preliminary idea of what your company is worth before conducting a deeper analysis.
The benefits are substantial. Internal diligence allows you to identify and fix potential issues before buyers see them, helping you maintain control over how information is disclosed. By initiating this process, you’ll also be able to provide buyers with a comprehensive, credible analysis that speeds up their review process and builds confidence in your business.
Most importantly, companies that complete vendor diligence often achieve higher valuations because they demonstrate transparency and reduce buyer uncertainty.
Interested in conducting early due diligence for an upcoming deal? Contact the team at Acquinox Advisors for a free consultation.
Practical Steps to Become Diligence-Ready
Preparing your business for due diligence requires systematic effort across multiple areas:
- Clean Up Documentation: Organize all financial records, contracts, corporate documents, and operational files in a logical structure. Ensure everything is current, complete, and easily accessible.
- Fix Identified Issues: Address known problems before buyers discover them. This might include resolving outstanding legal matters, updating expired contracts, strengthening cybersecurity, or improving financial controls.
- Organize a Virtual Data Room: Set up a secure, organized digital repository where all due diligence materials can be accessed. This demonstrates professionalism and speeds up the buyer’s review process significantly.
- Document Key Processes: Create written procedures for critical operations so buyers can understand how the business runs without relying entirely on institutional knowledge.
- Strengthen Key Relationships: Document and formalize important customer, supplier, and employee relationships. Consider retention agreements for critical personnel.
- Update Financial Projections: Ensure your forecasts are realistic, well-supported, and based on demonstrable assumptions that buyers can verify.
Get Diligence-Ready With Acquinox Advisors
The companies that close the strongest M&A deals are almost always the ones that prepare early and thoroughly for due diligence processes. When you proactively address potential red flags, organize comprehensive documentation, and present a transparent view of your business, you fundamentally change the negotiating dynamic.
Buyers typically move faster when due diligence goes smoothly and tend to offer better terms when they have confidence in what they’re acquiring. And they’re more likely to close deals when surprises don’t emerge late in the process.
Planning to sell your business? The team at Acquinox Advisors can help you prepare for due diligence, address potential red flags, and position your company for a successful transaction with the strongest possible terms.
