2 min read
What due diligence covers
Financial due diligence examines the quality and sustainability of earnings: reviewing three to five years of accounts, probing working capital trends, identifying exceptional items, and stress-testing the profit normalisation adjustments the seller has claimed. Legal due diligence covers contracts, property leases, employment terms, intellectual property ownership, and any litigation or regulatory exposure. Commercial due diligence assesses market position, customer relationships, and competitive dynamics.
On smaller deals, buyers sometimes combine financial and commercial diligence into a single engagement rather than running separate workstreams, to manage cost.
Organising the data room
A seller who prepares a well-organised virtual data room — containing contracts, accounts, employment records, IP registrations, and regulatory correspondence — signals a professional process and typically achieves a faster, cleaner completion. Gaps in the data room tend to prompt more questions, not fewer. Buyers should provide a structured information request list (Q-list) early to give the seller time to compile documents systematically.
How due diligence findings affect the deal
Material issues uncovered during due diligence can result in: a price reduction (often structured as an escrow holdback or purchase price adjustment); additional warranties or indemnities from the seller; a requirement for the seller to resolve the issue before completion; or, in serious cases, withdrawal from the deal. Minor issues are frequently absorbed into the deal price without renegotiation.
Limitations of due diligence
Due diligence does not guarantee that no issues exist — it identifies issues that are visible in the documents and management representations provided. Warranties and indemnities in the sale and purchase agreement, and warranty and indemnity (W&I) insurance where available, provide recourse if undisclosed liabilities emerge post-completion. Confirm appropriate legal protections with your solicitor.
Frequently asked questions
Does the buyer or the seller pay for due diligence?
Each party bears their own professional adviser costs. On larger deals, the seller may commission a vendor due diligence report to share with prospective buyers, which can reduce the buyer's own due diligence cost and timeline.
What is a red flag in financial due diligence?
Common red flags include: revenue concentrated in one or two customers, large related-party transactions without clear commercial rationale, deteriorating debtor days, significant off-balance-sheet commitments, and accounts that have not been independently prepared. None of these is necessarily a deal-breaker, but each requires a clear explanation from the seller.
Funding for UK limited companies
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