What Is Due Diligence?
Due diligence is the formal investigation of a target company to verify facts, identify risks, and confirm deal assumptions. It occurs after a letter of intent (LOI) is signed but before the definitive purchase agreement is executed.
Types of Due Diligence
Financial due diligence examines historical financials, quality of earnings, working capital trends, and accounting policies. Legal due diligence reviews contracts, litigation, IP, and regulatory compliance. Tax due diligence assesses tax positions and liabilities. Commercial due diligence evaluates market position, competition, and growth prospects. Operational due diligence examines capabilities, technology, and workforce.
Quality of Earnings (QoE)
The QoE report adjusts reported EBITDA for non-recurring items, related-party transactions, and accounting changes. QoE-adjusted EBITDA often becomes the basis for the final purchase price.
The Data Room
Targets provide information in a virtual data room (VDR) — a secure repository containing financial records, contracts, employee data, and other documents. Buyers review thousands of documents during diligence.
Impact on the Deal
Findings can result in purchase price adjustments, deal structure changes (escrow, indemnifications), additional conditions, or deal termination if material adverse findings emerge.
Timeline and Resources
Due diligence takes 4-8 weeks for mid-market deals and 2-4 months for complex transactions. It involves bankers, lawyers, accountants, and industry consultants reviewing management presentations and extensive documentation.
Role of Bankers
Buy-side bankers coordinate diligence, analyze findings, and assess valuation impact. Sell-side bankers prepare the target, manage the data room, and anticipate concerns.