Due diligence: what buyers actually examine

The workstreams, and the question behind each

Financial. Are the numbers real, and are they sustainable? Quality of earnings analysis strips out one-offs and accounting choices to establish what the business genuinely earns. This workstream produces more price adjustments than all the others combined.

Legal. Does the seller own what they are selling, and what obligations come with it? Corporate records, shareholdings, contracts, litigation, intellectual property, property leases.

Tax. Are there exposures the buyer will inherit? Historical positions, transfer pricing, VAT treatment, employee tax. Tax findings frequently produce indemnities rather than price reductions, because the exposure is contingent.

Commercial. Will the customers stay and does the market support the plan? Concentration, contract terms, churn, competitive position.

Operational. Can the business run without the seller, and what investment does it need? Systems, processes, capacity, deferred maintenance, key people.

Larger transactions add environmental, IT, insurance and regulatory workstreams. In South African deals, B-BBEE status and compliance history are examined closely, because they affect the acquired business's ability to win work.

What buyers look for that sellers do not anticipate

Some findings recur often enough to be predictable, and almost all of them are cheaper to fix beforehand.

Contracts that are terminable at will, or that contain change-of-control clauses allowing a customer to walk on a sale. A revenue base that looks contracted may be substantially cancellable.

Undocumented arrangements — the long-standing customer with no signed agreement, the supplier discount agreed verbally, the employee promised equity years ago.

Related-party transactions at non-market terms: property rented from an entity the owner controls, family members employed above market rate, loans in either direction.

Employment exposures — misclassified contractors, unpaid leave accruals, disciplinary matters mid-process.

Deferred capital expenditure. A business that has under-invested shows better margins than it sustainably supports, and the buyer will price the catch-up.

What findings do to a deal

Not everything reduces the price. Findings sort into four responses, and knowing which applies is useful.

Price reduction, where the finding permanently affects value — a customer lost, earnings overstated.

Indemnity, where a specific risk is identified but may never crystallise. The seller agrees to cover it if it does. Common for tax and litigation, and often better for a seller than an equivalent price cut, because it costs nothing if the risk never materialises.

Escrow or holdback, where part of the consideration is retained for a period against unknown claims.

Condition precedent, where something must be fixed before completion — a consent obtained, a contract signed, a liability settled.

These are covered in earn-outs, escrow and warranties. The seller's negotiating aim is generally to steer findings toward indemnities and conditions rather than price reductions, because those are contingent while a price cut is certain.

Preparing so that nothing surprises anyone

The most effective preparation is to run diligence on yourself before a buyer does. That means a vendor due diligence exercise or, at minimum, an honest internal review against the workstreams above.

Build the data room early: financials and management accounts, all material contracts, corporate records and share registers, employment documentation, tax returns and correspondence, property and lease agreements, insurance, litigation history, and intellectual property records. Index it properly.

Then find your own problems and form a view on each. A seller who discloses a known tax exposure with a calculated estimate and a legal opinion is treated as competent. The same exposure discovered by the buyer's advisers in week six is treated as concealment, and it re-frames everything found afterwards.

Practical note: nominate one person to manage the data room and the question log. Diligence generates hundreds of requests, and slow or inconsistent responses are read as either disorganisation or evasion, both of which cost money.

The data room, and what its condition signals

Buyers read the data room as evidence about the business itself, not merely as a source of documents.

An indexed, complete room with consistent file naming and documents that match what has been represented signals a business that is run properly. A room assembled in a rush, with gaps, superseded versions and contracts that turn out to be drafts, signals the opposite — and it invites a wider search, because the buyer now assumes there is more to find.

Practical points that consistently pay for themselves: include a document index with dates; resolve version control before uploading anything; provide signed contracts rather than drafts; and where a document is missing, say so explicitly with a reason rather than leaving a silent gap. Buyers are far more forgiving of a disclosed absence than of one they discover.

Track the question log as well. Response time is itself a signal, and a pattern of slow or partial answers on a particular topic will draw attention to that topic more reliably than the answer itself would have.

Running the business while this happens

Diligence consumes management time exactly when the business most needs to keep performing, because trading deterioration during a process is one of the commonest causes of deals collapsing or repricing.

Two defences work. Insulate the operating team — keep the people who run the business running it, and put the transaction load on the owner, the finance lead and the advisers. And agree a realistic timetable at the outset, because open-ended diligence is where fatigue does its damage.

Where the transaction is a venture or growth investment rather than an acquisition, the emphasis differs somewhat; VC due diligence in South Africa covers that version.