The Due Diligence Phase of an Acquisition

This article is written from the perspective of a buyer of a company in order to give the seller of a company an idea of what the buyer is looking for during the due diligence phase of an acquisition. This is the point where an acquirer has come in, made the decision to buy and both parties have signed a terms sheet or letter of intent. The terms sheet is a document that binds both companies in some way, so both companies have “skin in the game.”

Then the buyer can have full access to the seller’s information, and he can look at all of the details that would concern the acquisition of the company. During this phase the buyer will begin to ask questions like the following:

• What sort of business opportunities do we want to pursue with this acquisition?
• What skills do we have that will enhance the business’s existing model?
• What products produce the greatest margins?
• How will this enhance our portfolio or our existing model?
• What liabilities will we acquire when we make the acquisition?

Once the company has established a basis of questions such as these, the questions that affect the buyer’s interests the most, then it uses those questions to drive the due diligence research. While it is more than likely that the buyer will generate a list of documentation it needs to do the due diligence, this is not always possible. In such circumstances, it is important that the seller is patient while the buyer comes back and forth with questions and requests for documentation.

After the company has done enough research into the company that it is satisfied, the terms of the acquisition may or may not be negotiated further, depending on the dirt that has been dug out during the research. Once both parties have signed on the final bottom line then the deal is closed and the business is sold.

What Triggers the Due Diligence Phase

Due diligence begins formally after the signing of a letter of intent (LOI) or term sheet—a milestone that represents a meaningful turning point in the deal process. Before that point, a buyer is working from limited information: a confidential information memorandum (CIM), management presentations, and high-level financials. After the LOI is signed, the seller opens the books, and the buyer’s team moves from thesis formation to thesis verification.

The LOI itself is typically not fully binding—most provisions are explicitly non-binding pending the completion of due diligence and definitive documentation—but it does establish a period of exclusivity during which the seller agrees not to negotiate with other parties. This exclusivity provision is the mechanism that gives both sides “skin in the game,” as described above. The seller is exposed if the deal falls apart because they have turned away other potential buyers; the buyer is exposed because they have spent time and money on diligence with no guarantee of closing.

The Major Workstreams in Acquisition Due Diligence

Buyers typically organize due diligence into several parallel workstreams, each led by a different set of advisors. Understanding these workstreams helps a seller anticipate what is coming and prepare accordingly. A comprehensive due diligence request list will touch on all of these areas:

• Financial due diligence. Accountants review historical financial statements, test the quality of earnings, examine working capital, and identify any one-time or non-recurring items that may have flattered reported EBITDA. This workstream often surfaces adjustments that affect the final purchase price or require price-protection mechanisms such as escrow or earnout provisions.
• Legal due diligence. Attorneys review contracts (customer, supplier, employment, and lease agreements), intellectual property ownership, litigation history, regulatory compliance, and corporate records. Material contracts are examined for change-of-control provisions that might require consent from counterparties before the deal can close.
• Commercial due diligence. The buyer’s deal team validates the market opportunity, customer relationships, competitive positioning, and revenue concentration. This is where the strategic rationale for the acquisition—and the assumptions underpinning the buyer’s valuation model—are stress-tested against reality.
• Operational due diligence. Operations and technology teams assess the target’s systems, processes, and organizational structure. For technology companies or businesses with proprietary software, a technical audit of the codebase, infrastructure, and cybersecurity posture is commonly included.
• Tax due diligence. Tax advisors examine historic returns, identify potential exposures (state tax nexus issues, transfer pricing, payroll tax compliance), and advise on the optimal transaction structure—asset sale versus stock sale—from a tax perspective.

Managing the Data Room Effectively

A well-organized virtual data room is one of the most impactful things a seller can do to accelerate the diligence process. Buyers and their advisors spend a disproportionate amount of time during due diligence simply locating documents. A seller who anticipates the standard request list and pre-populates the data room reduces buyer frustration, demonstrates operational discipline, and—importantly—reduces the window during which diligence can uncover surprises that might reopen price negotiations.

Standard data room organization typically mirrors the major due-diligence workstreams: a financial folder containing audited statements and monthly management accounts, a legal folder organized by contract type, a corporate records folder, a tax folder, and an intellectual property folder. Version control and access logging are important for tracking which buyer representatives have reviewed which documents—information that can be valuable if questions arise later about what was disclosed.

What Happens When Due Diligence Uncovers Problems

Not all due diligence processes close cleanly. The article notes that after research is complete, “the terms of the acquisition may or may not be negotiated further, depending on the dirt that has been dug out.” In practice, the outcomes when problems surface fall into a few categories:

• Price reduction. If the identified issue has a quantifiable economic impact—an undisclosed liability, a customer contract that terminates on change of control, an environmental remediation obligation—buyers frequently seek a reduction in the purchase price proportional to the impact.
• Indemnification and escrow. For issues that are real but hard to quantify precisely, buyers may require the seller to indemnify them against losses up to a stated cap, with a portion of the purchase price held in escrow as security for indemnification claims.
• Earnout provisions. If due diligence reveals that revenue projections are aggressive or that key customer retention is uncertain, buyers may restructure a portion of the consideration as an earnout tied to post-closing performance benchmarks.
• Deal termination. In cases where diligence reveals a fundamental misrepresentation or a problem that renders the original deal thesis invalid, a buyer may exercise the right to terminate the LOI. The diligence dilemma of when to push forward versus walk away is one of the most difficult judgment calls in any M&A process.

Sellers who want to minimize the risk of renegotiation or termination are well served by conducting their own pre-diligence before going to market—a process sometimes called “vender due diligence” or “sell-side quality of earnings”—so that known issues can be disclosed proactively and framed in context rather than discovered by the buyer as surprises. The article on predictable questions in due diligence offers a practical framework for sellers preparing for this process.

If you are approaching a transaction and want to understand how to organize your diligence process from either side of the table, working through the key questions early—before an LOI is signed—will give you the best foundation for a smooth and successful close. Preparing a transaction outline is a practical first step.

Frequently Asked Questions

How long does the due diligence phase typically last?

The duration varies significantly by deal size and complexity, but thirty to sixty days from LOI signing is a common range for middle-market transactions. Larger or more complex deals—those involving significant regulatory approvals, multi-jurisdiction operations, or complex intellectual property portfolios—frequently require ninety days or more. Sellers can influence the timeline meaningfully by organizing their data room in advance and responding to information requests promptly.

Should a seller hire advisors to help manage the due diligence process?

Yes, in virtually all cases. The sell-side team typically includes an investment banker coordinating the overall process, a transaction attorney reviewing legal requests and negotiating the definitive agreement, and an accountant helping prepare for and respond to financial due diligence. Attempting to manage a sophisticated buyer’s diligence team without equivalent professional support is a significant disadvantage in the negotiation.

What is a data room index and why does it matter?

A data room index is a structured table of contents that maps each category of requested documents to the corresponding folder or file in the virtual data room. A clear index signals to buyers that the seller is organized and that the information they have requested is available. It also reduces the number of follow-up requests for documents that are present but hard to find, which keeps the process moving efficiently toward closing.