Key Considerations in Corporate Due Diligence for Mergers & Acquisitions

Without due diligence, any money on the table would inevitably go to the seller. Buyers always have a duty to shareholders to ensure no rock is left unearthed when it comes time to evaluate a target for acquisition. In software mergers it is of particular importance, as many key considerations with the software itself can be swept under the rug. Sifting through and picking out current and potential issues is always key in balancing a strategic acquisition in a particular niche endeavor.

Why Due Diligence Defines Deal Outcomes

Due diligence is not simply a legal formality — it is the mechanism through which buyers convert a seller’s representations into independently verified facts. Gaps in diligence translate directly into post-close surprises: unexpected liabilities, undisclosed litigation, customer concentration risk, or IP encumbrances that the target’s management either did not surface or actively obscured. The depth of diligence required scales with deal complexity, but the categories below apply across virtually every transaction.

Practitioners who want to track open items systematically across workstreams can use a structured diligence tracker to assign owners, deadlines, and status to each item on the request list.

Technology and Intellectual Property

Here are a few key considerations in the technology and IP workstream:

• Intellectual property. Are there any IP issues which could block the company from practicing or fully utilizing the potential of any technological breakthrough? If so, are there any work-around options?
• Human resources. Consideration should be given to all HR issues, including HR handbooks and guidelines.
• Legal risks of commercialization. This can go as broad and as deep as the ocean and is highly dependent on other issues unearthed during due diligence.
• Long-term product integrity. Is the business one that is sustainable? Is there a profit sanctuary and is the product robust enough to withstand competitive pressure?
• Development issues. What types of code and/or development issues or hurdles remain? If some exist, is there a plan and timeline for their completion?
• Integration of third-party IP. If third-party IP is required for the business to be sustainable, what are the legal and financial liabilities of making external IP work within the confines of the business?
• In-person interviews of software developers. This is always helpful and could create a separate list of technical follow-up items.
• Third-party patent clearance study. In some instances having a third-party patent attorney look over potential IP issues will be absolutely necessary. Better to pay a little up front rather than getting slapped with a huge lawsuit down the road.
• Inbound/outbound license agreements. Depending on how services flow, there are often expenses with inbound and outbound software license agreements. Knowing the process can sometimes open up many other questions. It is essential that diligence questions be asked on pricing as well as processes.
• Source-code escrow release agreements. What about the source code? How will it be transferred in the event of divestiture? How is it currently being transferred via employees and contractors?
• Potential unwritten side deals. Are there other deals, offers, giveaways, or agreements which are outside the scope of what the company initially represented? If so, what is outstanding?
• Company articles of incorporation and corporate bylaws. These are generally fairly boilerplate, but will be helpful in determining governance structure and any restrictive provisions.
• List of pending and/or threatened lawsuits against the company. Get the dirty laundry out and shake it out.

Employee Due Diligence

Due diligence on company employees:

• Existing employment issues
• Golden parachute arrangements
• General current and potential retention and compensation issues
• Non-compete covenants
• Stay bonuses
• New employment recommendations

Employee matters are frequently underestimated as a diligence category. Key-man dependency, undisclosed disputes with former employees, and misclassified contractors have derailed or re-priced more deals than buyers tend to expect going in. The importance of cultural integration is a related dimension that surfaces in post-close integration planning but is worth flagging during diligence itself.

Financial Due Diligence

Financial due diligence:

• Annual financial statements for five years (income statement, balance sheet, cash flow statements)
• Reconciliation of federal tax returns to annual income for preceding five years
• List of annual sales by product category including category, revenue, and gross margin
• List of annual revenue by marketing channel
• List of standard product lines including regularly stocked items along with the most recent cost per unit

Financial diligence goes beyond verifying the headline numbers. Quality-of-earnings analysis examines whether revenue is recurring or one-time, whether margins are sustainable or artificially inflated by deferred maintenance and underinvestment, and whether the business is generating real cash or papering over working-capital problems with favorable accounting choices.

Organizing the Diligence Process

The more knowledge the deal team has on the target company’s industry, the better equipped deal makers will be when it comes time to enter negotiation proceedings. This list is just preliminary, but is helpful in brainstorming due diligence questions which may arise as you attempt to buy or sell a business.

On the sell side, presenting organized, well-indexed materials reduces friction and signals operational competence to acquirers. A structured due diligence request list helps sellers anticipate buyer questions and prepare responsive documentation before the formal process begins. Organizing materials in a disciplined virtual data room workflow further accelerates the process and creates a defensible audit trail of what was disclosed and when.

Buyers who are approaching a transaction for the first time may also benefit from reviewing the buy-side support resources that outline the end-to-end acquisition process and common diligence pitfalls by deal type.

Frequently Asked Questions

What is the difference between legal due diligence and financial due diligence?

Legal due diligence focuses on the target’s corporate structure, contracts, IP ownership, litigation exposure, regulatory compliance, and employment matters. Financial due diligence examines the accuracy and quality of reported financial results, including revenue recognition practices, working capital dynamics, and off-balance-sheet liabilities. In most transactions, both workstreams run in parallel, and findings in one often generate follow-up questions in the other.

How long does a typical due diligence process take?

Timelines vary significantly by deal size and complexity. Small and mid-market transactions typically run four to eight weeks of active diligence after signing a letter of intent. Larger or more complex deals — those involving regulatory approvals, cross-border operations, or material IP portfolios — can run several months. Sellers who prepare a well-organized data room and anticipate common buyer questions can meaningfully compress this timeline.

What is a quality-of-earnings report and when is it required?

A quality-of-earnings (QoE) report is a financial analysis prepared by an independent accounting firm that examines the sustainability and accuracy of a target’s reported earnings. It adjusts for one-time items, normalizes owner compensation, and stress-tests revenue assumptions. QoE reports are standard on most private-equity-backed transactions and are increasingly common on any deal above a modest revenue threshold. Sellers who commission a sell-side QoE before going to market are typically better positioned to defend their financials during buyer diligence.