due-diligence

Due Diligence

Assess business opportunities through rigorous analytical frameworks. This covers commercial, operational, financial, strategic, and technology due diligence — from scoping the engagement through risk synthesis and investment recommendation.

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DD Types and When to Use Them

DD Type	Core Question	Focus Areas
Commercial	Can we win?	Market position, customers, growth, competitive dynamics
Operational	Can we run it?	Processes, systems, people, efficiency, scalability
Financial	Is it real?	Revenue quality, working capital, cash flow, projections
Strategic	Should we do it?	Strategic fit, synergies, integration, cultural compatibility
Technology & IP	Is it viable?	Architecture, technical debt, IP ownership, security
Legal & Regulatory	Is it clean?	Litigation, compliance, contracts, data privacy

Most transactions require at least commercial, operational, and financial DD. The mix depends on the deal.

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Phase 1: Scope Definition

Define the boundaries before doing any analysis. Unfocused DD wastes time and misses what matters.

Transaction Context

Establish:

• Transaction type: Acquisition, PE investment, strategic partnership, vendor assessment, internal assessment
• Target: Company name, industry, size
• Deal value: Estimated range
• Timeline: How much time for DD
• Access: Data room contents, management availability, ability to speak with customers/suppliers
• Team: Who's doing the work, what expertise is available

Focus Area Prioritization

Area	Priority	Key Questions	Data Available?
Market	High/Med/Low	What must we understand about the market?	Y/N
Customers	High/Med/Low	What must we understand about the customer base?	Y/N
Operations	High/Med/Low	What must we understand about how the business runs?	Y/N
Financials	High/Med/Low	What must we validate about the numbers?	Y/N
Technology	High/Med/Low	What must we understand about the tech stack?	Y/N
Legal/Regulatory	High/Med/Low	What risks need legal review?	Y/N

Prioritize ruthlessly. Focus on what could kill the deal or materially change the price.

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Phase 2: Information Gathering

Information Request List

Corporate:

• Articles of incorporation
• Board minutes (last 2 years)
• Organizational charts
• Shareholder agreements
• Material contracts and amendments

Financial:

• Audited financials (3-5 years)
• Monthly management accounts (last 24 months)
• Revenue by segment, product, geography, customer
• Cash flow statements
• Debt schedules and covenant compliance
• Budget vs. actual analysis (last 2 years)
• Tax returns and outstanding tax positions

Commercial:

• Customer list with revenue by customer (last 3 years)
• Contract templates and key customer contracts
• Pricing history and discount schedules
• Sales pipeline and win/loss data
• Customer churn data and reasons
• NPS or customer satisfaction data

Operational:

• Process documentation for key workflows
• Technology systems inventory
• Key vendor list with spend and contract terms
• Headcount by function, level, tenure
• Capacity utilization data
• Quality metrics and incident history

Technology:

• Architecture diagrams
• Technical debt assessment (if available)
• Security audit results
• IP portfolio (patents, trademarks, trade secrets)
• Open-source dependency audit
• Development team metrics (deploy frequency, incident response)

Legal:

• Pending or threatened litigation
• Regulatory filings and compliance status
• Material contract summary
• Insurance policies
• Data privacy compliance documentation

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Phase 3: Analysis

Commercial Due Diligence

Market Assessment

Metric	Finding	Source	Confidence
Total addressable market (TAM)	$	Industry reports, bottom-up analysis	H/M/L
Target's market share	%	Company data vs. market estimates	H/M/L
Market growth rate (CAGR)	%	Historical trend, analyst consensus	H/M/L
Market position	#X of Y competitors	Competitive analysis	H/M/L

Key questions: Is the market growing or shrinking? Is growth structural or cyclical? What disruption risks exist? How defensible is the target's position?

Customer Analysis

Metric	Finding	Risk Level	Trend
Top 10 customer concentration	% of revenue	H/M/L	Improving/Stable/Worsening
Average contract value	$		Direction
Net revenue retention (NRR)	%	Above/Below 100%	Direction
Gross churn rate	%	vs. industry benchmark	Direction
Logo churn rate	%	Segment comparison	Direction
Average contract duration	months	vs. industry	Direction

Customer concentration above 20% in top 3 customers is a yellow flag. Above 40% is a red flag. NRR below 100% means the installed base is shrinking — the business must sell faster than it leaks.

Revenue Quality

Metric	Finding	Assessment
Recurring vs. one-time revenue	% recurring	Strong (>80%) / Moderate (50-80%) / Weak (<50%)
Revenue recognition risks	Assessment	H/M/L
Backlog / committed revenue	$	Coverage ratio vs. plan
Pricing power	Assessment	Expanding / Stable / Eroding
Cross-sell / upsell as % of new ACV	%	Growing or declining

Competitive Position

Factor	Target	Comp A	Comp B	Assessment
Market share	%	%	%	Position and trajectory
Pricing	$	$	$	Premium / Par / Discount
Differentiation	Claim	Claim	Claim	Sustainable?
Win rate vs. competitors	%	—	—	Strong / Weak

Operational Due Diligence

Process and Efficiency

Area	Finding	Risk	Improvement Potential
Capacity utilization	%	H/M/L	Assessment
Key process bottlenecks	Findings	H/M/L	Assessment
Automation level	%	H/M/L	Assessment
Quality metrics	Findings	H/M/L	Assessment

Technology Assessment

Area	Finding	Risk	Detail
Architecture scalability	Assessment	H/M/L	Can it support 3-5x growth?
Technical debt	Quantified estimate	H/M/L	Remediation cost and timeline
IP ownership and protection	Status	H/M/L	Patents, trade secrets, licenses
Security posture	Assessment	H/M/L	Last audit, certifications, incidents
Data architecture	Findings	H/M/L	Quality, governance, portability
Open-source dependencies	Audit status	H/M/L	License compliance, security
Development velocity	Metrics	H/M/L	Deploy frequency, lead time, MTTR
Cloud infrastructure	Status	H/M/L	Provider, costs, lock-in risk

Management and Team

Dimension	Finding	Risk	Detail
Leadership depth	Assessment	H/M/L	Bench strength below C-suite
Key person dependencies	Names/roles	H/M/L	Single points of failure
Succession planning	Status	H/M/L	Documented plans, readiness
Track record	Performance history	H/M/L	Delivery on past commitments
Cultural assessment	Findings	H/M/L	Values, decision-making, adaptability
Retention risk	Assessment	H/M/L	Turnover trends, engagement, comp benchmarking
Organizational structure	Assessment	H/M/L	Efficiency, spans of control, layers

Management assessment often predicts post-deal success better than financial analysis. A mediocre business with a strong team outperforms a strong business with a mediocre team.

Financial Due Diligence

Quality of Earnings

Item	Reported	Adjusted	Adjustment Reason
Revenue	$	$	Non-recurring items, timing differences
EBITDA	$	$	One-time costs, owner compensation, related-party transactions
Net income	$	$	Normalizing adjustments

The gap between reported and adjusted EBITDA tells you how much the seller is dressing up the numbers. Adjustments exceeding 20% of reported EBITDA warrant extra scrutiny.

Working Capital

Component	Current	Trend	Seasonal Pattern	Cash Impact
Accounts receivable	$ (X days)	Direction	Pattern	$
Accounts payable	$ (X days)	Direction	Pattern	$
Inventory	$ (X days)	Direction	Pattern	$
Net working capital	$	Direction	Pattern	Funding need

Working capital is where deals get renegotiated. Establish a normalized working capital figure and tie the purchase price to it. Seasonal businesses require month-by-month analysis.

Capital Expenditure

Category	Historical (3-year avg)	Forecast	Maintenance vs. Growth
Category 1	$/yr	$/yr	Split
Category 2	$/yr	$/yr	Split

Distinguish maintenance capex (required to keep the business running) from growth capex (investment in expansion). Underinvestment in maintenance capex flatters short-term earnings but creates a liability.

Cash Flow

Metric	Year -2	Year -1	Current	Trend
Operating cash flow	$	$	$	Direction
Free cash flow	$	$	$	Direction
Cash conversion (FCF/EBITDA)	%	%	%	Direction

Cash conversion below 70% needs explanation. Common culprits: growing working capital, high capex, or earnings quality issues.

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Phase 4: Risk Assessment

Risk Categorization

Critical risks (deal killers) — Issues that could make the deal unviable:

Risk	Likelihood	Impact	Mitigation
Risk description	H/M/L	H/M/L	What can be done

Examples: undisclosed litigation, regulatory non-compliance, fraud indicators, irreplaceable key person with no retention plan, market in structural decline.

Major risks (deal adjustments) — Issues that materially affect valuation or deal terms:

Risk	Likelihood	Impact	Mitigation
Risk description	H/M/L	H/M/L	What can be done

Examples: customer concentration, technical debt requiring significant remediation, management gaps, integration complexity.

Minor risks (price adjustments) — Issues that affect value but are manageable:

Risk	Likelihood	Impact	Mitigation
Risk description	H/M/L	H/M/L	What can be done

Examples: operational inefficiencies (often upside opportunities), minor compliance gaps, below-market compensation structures.

Red Flag Indicators

Watch for these — any one of them warrants deeper investigation:

• Revenue acceleration in the run-up to sale (pulling revenue forward)
• Unusual changes in accounting policies or estimates
• Customer concentration increasing while being presented as "diversified"
• Key employees departing in the months before the transaction
• Capital expenditure declining while revenue grows (underinvestment)
• Working capital trends diverging from revenue trends
• Related-party transactions at non-market terms
• Gaps or inconsistencies between management presentations and data room documents
• Reluctance to provide access to customers or key employees

Red flags are not necessarily deal killers. They're signals to investigate further. Sometimes the explanation is benign. Sometimes it changes the deal.

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Phase 5: Synthesis and Recommendation

Investment Thesis

Frame the deal in terms of:

1. What makes this attractive — the strategic rationale and value creation opportunity
2. What could go wrong — the key risks and their mitigations
3. What the deal is worth — implied valuation given the findings

Recommendation Format

## Due Diligence Summary: [Target]

### Investment Thesis
[One paragraph: why this deal makes sense or doesn't]

### Key Strengths
1. [Strength with evidence]
2. [Strength with evidence]

### Key Concerns
1. [Concern with evidence and mitigation]
2. [Concern with evidence and mitigation]

### Risk Assessment
| Category | Risk Level | Key Risks |
|----------|------------|-----------|
| Commercial | H/M/L | [Risks] |
| Operational | H/M/L | [Risks] |
| Financial | H/M/L | [Risks] |
| Strategic | H/M/L | [Risks] |
| Technology | H/M/L | [Risks] |

### Valuation Implications
| Factor | Adjustment |
|--------|------------|
| Revenue quality adjustments | +/-$ or % |
| Customer risk discount | -$ or % |
| Operational improvement upside | +$ or % |
| Integration costs | -$ |
| Net adjustment | $ or % |

### Recommendation
[PROCEED / PROCEED WITH CONDITIONS / DO NOT PROCEED]

### Conditions Precedent (if proceeding)
1. [Condition — rationale]
2. [Condition — rationale]

### Next Steps
1. [Action — owner — timeline]
2. [Action — owner — timeline]

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Integration Assessment (M&A Context)

When DD is for an acquisition, integration planning starts during DD, not after close.

Integration Complexity

Area	Complexity	Timeline	Key Dependencies	Cost Estimate
Systems integration	H/M/L	Months	Dependencies	$
Organization integration	H/M/L	Months	Dependencies	$
Customer migration	H/M/L	Months	Dependencies	$
Process harmonization	H/M/L	Months	Dependencies	$
Culture integration	H/M/L	Months	Dependencies	$

Synergy Quantification

Synergy	Type	Year 1	Year 2	Year 3	Confidence	Risk
Revenue synergy	Revenue	$	$	$	H/M/L	Timing risk
Cost synergy 1	Cost	$	$	$	H/M/L	Execution risk
Cost synergy 2	Cost	$	$	$	H/M/L	Execution risk

Cost synergies are generally more reliable than revenue synergies. Revenue synergies take longer to materialize and depend on customer behavior you can't fully control. Discount revenue synergies by 50% in your base case.

Day 1 Readiness

• Communication plan for employees, customers, vendors
• Interim operating model defined
• Key talent retention packages in place
• Regulatory approvals obtained
• IT systems access and continuity plan
• Customer-facing team briefed and scripted

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Context Adaptation

Adapt the DD approach based on the deal context:

Context	Emphasis
M&A	Synergy assessment, integration complexity, valuation adjustments, Day 1 readiness
PE Investment	Value creation levers, exit scenarios, management incentive alignment, 100-day plan
Strategic Partnership	Capability complementarity, cultural fit, governance model, IP sharing terms
Vendor Assessment	Operational reliability, financial stability, contractual protections, business continuity
Internal Assessment	Capability gaps, improvement priorities, investment needs (drop M&A terminology)

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Working Principles

• Focus on materiality. Prioritize issues that could kill the deal or change the price by more than 5%. Don't spend equal time on everything.
• Triangulate everything. Management tells one story. The data room tells another. Customers and suppliers tell a third. The truth is somewhere in the overlap.
• Red flags are negotiation tools, not always walk-away signals. A customer concentration risk discovered in DD becomes a price adjustment or an earn-out structure.
• Document all assumptions and limitations. What you couldn't verify is as important as what you confirmed. Future you (or the lawyer) will need to know.
• Connect findings to valuation. Every DD finding should translate to "and that means the deal is worth more/less/the same because..."
• Start integration planning during DD. The information you gather during DD is the foundation for the integration plan. Don't throw it over the wall and start fresh.
• Operational DD reveals upside. Financial DD finds problems. Operational DD often finds improvement opportunities — inefficiencies the acquirer can fix, capabilities the acquirer can scale.
• Talk to customers and suppliers when possible. Management representations are necessary but insufficient. External validation changes the picture more often than you'd expect.