Due Diligence
Due diligence is the process in which a buyer examines a target's financial, legal, tax, and operational records before committing to a deal. What the buyer finds can change the price and the terms of the deal.
What buyers examine in a target's records. Before committing, a buyer checks whether the target is what it appears to be. The examination covers four areas of records.
- Financial records: the statements and figures behind the price. The buyer checks whether reported revenue and profit are real and repeatable, because the valuation rests on them.
- Legal records: contracts, ownership of assets, and any disputes. The buyer looks for obligations or claims that could pass to the new owner.
- Tax records: how the target has handled its taxes. Unpaid or disputed amounts can become the buyer's problem after closing.
- Operational records: how the business actually runs day to day, such as its customers, suppliers, and processes.
The purpose is the same across all four: to find out what the buyer is really buying before it is bound to buy.
How diligence findings affect price and deal terms. Diligence findings feed back into the deal. A finding can lower the price the buyer is willing to pay, or it can change the terms instead of the price.
The logic follows from valuation. A price is built on assumptions about earnings and risk. If diligence shows earnings are lower than presented, the value falls and the price can fall with it. If diligence reveals a risk, such as a possible legal claim or a tax exposure, the buyer can ask for a lower price, for protections written into the terms, or both. A serious enough finding can lead the buyer to walk away.
The seller's side matters too: a clean result supports the original price, while problems give the buyer grounds to renegotiate.
Listing diligence questions and judging which findings move the price. For any given target, start by asking what could make the target worth less than it appears, then turn each concern into a question for the records. For example: Are the reported earnings supported by the financial records? Are there contracts or disputes in the legal files that create obligations? Are there tax positions that could produce a later bill? Does the operation depend on a few customers or suppliers?
Then explain which findings would change the price. A finding changes the price when it affects the target's expected earnings or adds a cost or liability the buyer would inherit. A finding that leaves earnings and obligations unchanged has little reason to move the price. :::callout Try it Pick a target, list the diligence questions you would ask about it, and explain which findings would change the price.
