What Actually Happens in Due Diligence
Updated: Sep 29
Due diligence is where deals die. Not because buyers find fraud, which is rare, but because they find surprises, and surprises erode confidence at exactly the moment a buyer is deciding whether to wire several million dollars.
Here is what the process actually involves and where owners get caught.
Financial diligence
The buyer, usually with an accountant, will reconcile your reported earnings to bank statements and tax returns, test your add-backs line by line, examine revenue recognition, review margins by customer and product line, and look for working capital trends. If a quality of earnings report is commissioned, expect this to be thorough.
Where it stalls: undocumented add-backs, cash transactions that never hit the books, inventory that cannot be substantiated, and any gap between what the tax return says and what the seller claims the business earns.
Legal and contractual diligence
Counsel will review entity formation and good standing, ownership records, customer and supplier contracts including assignment provisions, leases and landlord consent requirements, employment agreements, non-competes, licenses and permits, insurance history, and any litigation past or pending.
Where it stalls: contracts that cannot be assigned without consent, leases with change-of-control provisions, missing corporate records, and licenses held personally by the owner rather than by the company.
Operational diligence
Buyers assess whether the business runs without you: management depth, documented processes, systems and software, employee tenure and turnover, and key-person dependencies. They will often want to meet key employees, which requires careful timing and confidentiality management.
Lender diligence, if the buyer is financing
On SBA and conventional deals, the lender runs its own parallel process, and it is frequently the actual critical path. The lender's underwriter will re-test the add-backs, may order an equipment appraisal or business valuation, and will size the loan on their view of earnings, not yours. Every add-back their underwriter rejects reduces what the buyer can borrow, which reduces what they can pay.
How to prepare
Three things separate smooth diligence from a renegotiation. First, do your own diligence before going to market so nothing surprises you. Second, build the data room in advance with documents organized and complete, because response speed signals competence and slow responses signal problems. Third, disclose known issues early and in writing. A problem you raise is a footnote; the same problem discovered in week eight is a price reduction.
Common questions
How long does due diligence take?
Typically months five through nine of a six to ten month process, running in parallel with the buyer's lender underwriting if they are borrowing.
What do buyers examine in diligence?
Financial: earnings reconciled to bank statements and tax returns, every add-back tested. Legal: entity records, contract assignability, leases, licenses, insurance, litigation. Operational: whether the business runs without the owner.
Why do deals die in diligence?
Not usually fraud, which is rare, but surprises. Undocumented add-backs, contracts that cannot be assigned, leases with change-of-control provisions, and licenses held personally rather than by the entity are the common causes.
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