Required Inputs
- Target Company: Name, industry, size (revenue, EBITDA, headcount), and brief description.
- Transaction Type: Buy-side (acquirer's perspective) or sell-side / vendor DD (seller preparing for market).
- Deal Thesis: Strategic rationale — why this acquisition makes sense (synergies, market access, capability, scale, vertical integration).
- Deal Structure: Asset deal vs. share deal; expected consideration type (cash, stock, earnout).
- Timeline: Expected DD window (typically 4-8 weeks); exclusivity expiration date if applicable.
- Budget / Scope Constraints: Which workstreams are in scope; any areas requiring specialist advisors.
Execution Steps
1. DD Scoping
Scope varies significantly between buy-side and sell-side engagements.
Buy-Side DD Focus:
| Workstream | Primary Objective | Key Questions |
|---|---|---|
| Financial | Validate earnings quality; identify hidden liabilities | Is EBITDA real and sustainable? What is true net debt? |
| Commercial | Confirm market position and revenue durability | Will customers stay? Is the market growing? Is the moat real? |
| Legal | Identify legal exposure and deal impediments | Are there change-of-control issues? Litigation? IP risks? |
| Operational | Assess scalability and integration complexity | Can we integrate this? What will break? Key person risks? |
| Technology | Evaluate tech assets and technical debt | Is the tech an asset or liability? What is the rebuild cost? |
| HR / Cultural | Assess people risks and cultural compatibility | Will key talent stay? Are there hidden liabilities? Culture clash? |
Sell-Side (Vendor) DD Focus:
| Workstream | Primary Objective | Key Questions |
|---|---|---|
| Financial | Present clean, adjusted financials proactively | How do we present EBITDA in the best defensible light? |
| Commercial | Build the equity story with supporting data | What is the compelling growth narrative? Market proof points? |
| Legal | Identify and remediate issues before buyer finds them | What can we fix before going to market? |
| Operational | Demonstrate operational readiness for new ownership | Can the business run independently? Transition service needs? |
| Technology | Showcase tech differentiation; remediate known issues | What is our tech competitive advantage? |
| HR / Cultural | Demonstrate stable, capable team | How do we retain key people through the process? |
2. DD Workstream Details
Workstream 1: Financial Due Diligence
Quality of Earnings (QoE) Analysis:
Start with reported EBITDA and systematically adjust:
| Adjustment Category | Description | Direction | Examples |
|---|---|---|---|
| Non-recurring revenue | Revenue that will not repeat under new ownership | Subtract | One-time project fees, litigation settlement income, government grants |
| Non-recurring expenses | Costs that will not recur post-close | Add back | Restructuring charges, litigation costs, one-time bonuses, IPO costs |
| Owner adjustments | Above-market compensation or personal expenses | Add back | Owner salary above market, personal travel, related-party rent above market |
| Accounting policy differences | Adjustments to normalize to standard policies | +/- | Revenue recognition timing, capitalization vs. expensing, reserve levels |
| Pro forma adjustments | Full-year effect of mid-year changes | +/- | Annualize acquisitions, new contracts, or cost savings started mid-year |
| Run-rate adjustments | Known future changes not yet in financials | +/- | Signed contracts not yet billing, committed cost reductions, price increases |
Adjusted EBITDA Bridge:
Reported EBITDA $___M
+ Non-recurring expense add-backs $___M
- Non-recurring revenue subtractions ($___M)
+ Owner / related-party adjustments $___M
+/- Accounting policy normalizations $___M
+/- Pro forma adjustments $___M
+/- Run-rate adjustments $___M
= Adjusted EBITDA $___M
Working Capital Normalization:
| Component | Calculation | Months to Analyze | Key Tests |
|---|---|---|---|
| Accounts Receivable | DSO trend; aging analysis; bad debt history | 24-36 months | Unusual spike near period-end? Customer concentration? |
| Inventory | DIO trend; obsolescence; write-off history | 24-36 months | Aging increasing? Slow-moving categories? |
| Accounts Payable | DPO trend; supplier concentration | 24-36 months | Stretching payables to manage cash flow? Supplier dependency? |
| Other WC items | Accruals, prepayments, deposits, deferred revenue | 24-36 months | Large swings? Deferred revenue recognition changes? |
| Normalized NWC | Average of normalized months (exclude outliers) | Peg mechanism for closing adjustment |
Net Debt Bridge:
| Item | Value | Notes |
|---|---|---|
| Funded debt (bank loans, bonds) | $___M | Face value |
| Capital leases / finance leases | $___M | Post-IFRS 16 / ASC 842 |
| Unfunded pension liability | $___M | Actuarial deficit |
| Deferred consideration (prior acquisitions) | $___M | Outstanding earnouts owed |
| Tax liabilities (overdue or disputed) | $___M | Net of expected refunds |
| Litigation provisions | $___M | If probable and estimable |
| Less: Cash and cash equivalents | ($___M) | Unrestricted only |
| Less: Excess cash above operating needs | ($___M) | If segregated |
| Net Debt | $___M |
Workstream 2: Commercial Due Diligence
Market Sizing Cross-Reference:
Validate the target's stated TAM/SAM/SOM using at least two independent methods:
- Top-down: Industry reports, analyst estimates, government statistics.
- Bottom-up: Customer count x average spend x penetration rate.
- Triangulate: Check that the target's revenue as % of SAM is plausible.
Customer Concentration Analysis:
| Customer | Revenue ($M) | % of Total | Contract Expiry | Switching Cost | Risk |
|---|---|---|---|---|---|
| Customer 1 | Low/Med/High | ||||
| Customer 2 | Low/Med/High | ||||
| Top 5 total | X% | ||||
| Top 10 total | X% | ||||
| Top 20 total | X% |
Red flag thresholds:
- Top 1 customer > 20% of revenue: High concentration risk.
- Top 5 customers > 50% of revenue: Moderate-high concentration risk.
- Top 10 customers > 70% of revenue: Moderate concentration risk.
Competitive Moat Assessment:
| Moat Type | Evidence Present | Strength (1-5) | Sustainability |
|---|---|---|---|
| Network effects | [Y/N — describe] | [Durable / Eroding / Emerging] | |
| Switching costs | [Y/N — describe] | [Durable / Eroding / Emerging] | |
| Scale economies | [Y/N — describe] | [Durable / Eroding / Emerging] | |
| Brand / Reputation | [Y/N — describe] | [Durable / Eroding / Emerging] | |
| IP / Patents | [Y/N — describe] | [Durable / Eroding / Emerging] | |
| Regulatory barriers | [Y/N — describe] | [Durable / Eroding / Emerging] | |
| Data advantage | [Y/N — describe] | [Durable / Eroding / Emerging] |
Workstream 3: Legal Due Diligence
| Area | Key Items to Review | Red Flag Indicators |
|---|---|---|
| Material contracts | Top 20 contracts by value; change-of-control provisions; exclusivity; MFN clauses | Contracts terminable on change of control without consent; onerous exclusivity |
| Litigation | Pending and threatened claims; regulatory investigations; historical settlements | Unresolved material claims; pattern of similar litigation; regulatory investigation |
| IP ownership | Patent portfolio; trademark registrations; trade secrets; open-source compliance | IP created by contractors without assignment; open-source license contamination |
| Employment | Employment agreements; non-competes; severance obligations; wage-and-hour compliance | Mass non-compete expirations post-close; unpaid overtime exposure; misclassification |
| Regulatory | Licenses and permits; compliance history; pending regulatory changes | Expired or at-risk licenses; history of violations; upcoming regulation threatening model |
| Tax | Tax returns (3-5 years); transfer pricing; tax disputes; structural exposures | Aggressive positions; open audits with material exposure; NOL limitations on change of control |
| Environmental | Phase I/II assessments; remediation obligations; compliance history | Known contamination; pending remediation; Superfund site exposure |
| Data privacy | GDPR/CCPA compliance; data processing agreements; breach history | Prior breaches; non-compliant data practices; cross-border transfer issues |
Workstream 4: Operational Due Diligence
| Area | Assessment Focus | Key Questions |
|---|---|---|
| Supply chain | Supplier concentration; single-source risks; lead times; logistics | Any single-source suppliers for critical inputs? Geographic concentration? |
| Key person dependency | Identify roles where departure = material business impact | What happens if the founder/CEO/CTO leaves? Are there successors? |
| Scalability | Can operations scale 2-3x without fundamental redesign? | What breaks at 2x revenue? Capacity constraints? |
| Quality and compliance | Quality management system; defect rates; certifications | ISO certifications current? Customer quality complaints trending? |
| Facilities | Lease terms; capacity utilization; capex needs | Lease expiry alignment with hold period? Deferred maintenance? |
| IT infrastructure | Systems maturity; disaster recovery; cybersecurity posture | Last penetration test? DR tested? Systems integrated or siloed? |
Workstream 5: Technology Due Diligence
| Area | Assessment Focus | Scoring (1-5) |
|---|---|---|
| Architecture | Monolith vs. microservices; scalability; technical debt level | 1=Legacy monolith, 5=Modern cloud-native |
| Code quality | Test coverage; deployment frequency; incident rate; documentation | 1=No tests, no docs, 5=>80% coverage, CI/CD, well-documented |
| Security | Vulnerability management; pen test results; SOC 2 / ISO 27001 | 1=No security program, 5=Certified, tested, monitored |
| Data assets | Data quality; uniqueness; competitive advantage from data | 1=Poor quality, commodity, 5=Unique, clean, defensible |
| Team | Engineering talent quality; retention; key person risk | 1=High attrition, thin, 5=Strong team, deep bench |
| IP / Product | Proprietary algorithms; patents; product-market fit | 1=Commodity/easily replicated, 5=Strong IP moat |
| Scalability | Can the platform handle 10x current load? | 1=Will break at 2x, 5=Proven at scale with headroom |
| Tech debt | Estimated cost to remediate critical tech debt | 1=>$5M to remediate, 5=Minimal debt |
Workstream 6: HR & Cultural Due Diligence
| Area | Assessment Focus | Red Flag Indicators |
|---|---|---|
| Org structure | Layers, spans, key roles, succession planning | Over-reliance on founder; no succession plan for key roles |
| Compensation | Salary benchmarking; equity/options outstanding; retention packages | Below-market comp with no equity = flight risk; large option pool dilution |
| Benefits & liabilities | Pension obligations; post-employment benefits; accrued leave | Underfunded pension; large accrued leave balances; OPEB liabilities |
| Employment compliance | Contractor classification; overtime compliance; handbook completeness | Misclassified contractors (IC vs. employee); missing handbook policies |
| Talent retention | Voluntary attrition rate (last 3 years); engagement survey scores | Attrition >20%; declining engagement; key departures pre-announcement |
| Cultural assessment | Values alignment; management style; decision-making norms | Significant values mismatch with acquirer; command-and-control vs. empowerment |
3. Red Flag Identification and Classification
Every finding must be classified by severity. Use strict definitions:
| Severity | Definition | Typical Examples | Deal Action |
|---|---|---|---|
| Deal Breaker | Fundamentally undermines deal thesis; cannot be remediated at acceptable cost | Fraud; undisclosed material litigation; regulatory prohibition; target does not own its core IP | Walk away or fundamentally restructure deal |
| Material | Significant impact on valuation (>5% of EV) or deal structure | Quality of earnings adjustments >15% of EBITDA; key customer at risk; material compliance gap; unfunded pension >10% of EV | Price adjustment, indemnity, escrow, or structural protection |
| Manageable | Addressable post-close with known cost and timeline | Tech debt requiring $1-3M remediation; 2-3 key hires needed; process gaps fixable in 6 months | Factor into integration plan and budget |
| Noted | Minor issue; no material impact; documented for completeness | Expired non-material contract; minor policy gap; cosmetic financial restatement | Document only; no action required |
4. Integration Complexity Scoring
Score integration complexity across 8 dimensions (1-5 scale):
| Dimension | 1 (Simple) | 3 (Moderate) | 5 (Complex) | Target Score |
|---|---|---|---|---|
| Systems overlap | No shared systems; standalone | Some system overlap; phased migration | Deep system entanglement; big-bang required | |
| Geographic overlap | Same country; same timezone | Same region; 2-3 countries | Global; 5+ countries; regulatory variation | |
| Customer overlap | <5% customer overlap | 10-20% overlap; manageable conflict | >30% overlap; significant cannibalization risk | |
| Product integration | Complementary; no overlap | Some overlap; portfolio rationalization needed | Significant overlap; product retirement required | |
| Cultural distance | Similar culture and values | Some differences; manageable with effort | Fundamentally different cultures; merger of equals dynamic | |
| Regulatory complexity | Same regulatory regime | Some additional regulatory approvals | Multiple jurisdictions; antitrust risk; foreign investment review | |
| People integration | Minimal overlap; mostly additive | Some role duplication; selection needed | Significant redundancy; large-scale role elimination | |
| Operational integration | Independent operations; tuck-in | Shared services consolidation | Full operational merger; new operating model needed |
Overall integration complexity: Average of dimension scores.
| Score | Complexity Level | Typical Integration Timeline | Integration Cost (% of deal value) |
|---|---|---|---|
| 1.0 - 2.0 | Low | 3-6 months | 1-3% |
| 2.1 - 3.0 | Moderate | 6-12 months | 3-5% |
| 3.1 - 4.0 | High | 12-18 months | 5-8% |
| 4.1 - 5.0 | Very High | 18-36 months | 8-15% |
5. Data Room Request List
Organized by workstream. Send this to the target as the initial information request.
Financial (40-50 items):
- Audited financial statements (last 3-5 years)
- Monthly management accounts (last 24 months)
- Revenue by customer, product, geography (last 3 years)
- Detailed cost breakdown by category (last 3 years)
- Working capital detail (monthly, last 24 months)
- Debt agreements and amendments
- Capital expenditure schedule (actual and planned)
- Tax returns and correspondence with tax authorities (last 3-5 years)
- Budget and forecast (current year and forward plan)
- Related-party transactions detail
Commercial (20-30 items):
- Top 20 customer contracts
- Customer list with revenue, tenure, and contract terms
- Sales pipeline and bookings report
- Pricing history and scheduled price changes
- Churn analysis and customer loss reasons (last 3 years)
- Market studies or analyst reports referenced in management materials
- Competitor analysis and win/loss data
- Channel partner agreements
Legal (30-40 items):
- All material contracts (>$[X] annual value)
- Litigation summary (pending, threatened, settled in last 5 years)
- IP schedule (patents, trademarks, copyrights, domain names)
- Employment agreements for key executives
- Lease agreements for all facilities
- Insurance policies and claims history
- Regulatory licenses and permits
- Data processing agreements and privacy policies
Operational (15-20 items):
- Organization chart with headcount by function
- Key supplier contracts and terms
- Quality certifications and audit results
- Facilities list with lease terms and capacity utilization
- Business continuity and disaster recovery plans
- Key operational metrics and KPIs (last 3 years)
Technology (15-20 items):
- Technology architecture diagram
- Third-party software licenses and contracts
- Security audit reports and penetration test results
- Development roadmap and backlog
- System uptime and incident history (last 12 months)
- Data architecture and data flow diagrams
HR (15-20 items):
- Employee census (name, role, tenure, compensation, location)
- Organization chart by function and level
- Benefits summary and costs
- Employment agreements, non-competes, and change-of-control provisions
- Attrition data (voluntary and involuntary, last 3 years)
- Engagement survey results (last 2 surveys)
- Outstanding equity grants and option pool
6. Management Presentation Question Bank
Critical questions to ask the target management team (minimum 25):
Strategy & Market:
- What is your sustainable competitive advantage and what threatens it?
- Which competitors worry you most and why?
- What is the single biggest risk to your business in the next 3 years?
- How would you grow the business with $[X]M additional investment?
- Which customers are you most at risk of losing and why?
Financial: 6. Walk us through EBITDA adjustments — what do you consider truly non-recurring? 7. What is your typical cash conversion cycle and how has it changed? 8. Where are the largest areas of management judgment in your financials? 9. Are there any off-balance-sheet commitments or contingent liabilities? 10. What is driving the trend in gross margin over the last 3 years?
Customers & Revenue: 11. What would it take for your largest customer to leave? 12. How do you acquire new customers and what is the cost of acquisition? 13. What is your net revenue retention rate and how is it trending? 14. Are any material contracts up for renewal in the next 12 months? 15. How much of your pipeline is committed vs. speculative?
Operations: 16. What breaks if the business doubles in size? 17. Where are the key person dependencies and what is the succession plan? 18. What are the top 3 operational improvements you would make with more resources? 19. Have you experienced any significant supply chain disruptions? How did you respond? 20. What is your biggest quality or delivery challenge?
Technology: 21. What is the most significant technical debt and what would it cost to fix? 22. How would you rate your cybersecurity posture on a 1-10 scale? 23. What is on your technology roadmap for the next 18 months and why? 24. Are there any open-source license compliance concerns? 25. What systems or technology would need to change in an acquisition?
People & Culture: 26. Who are the 5 people you cannot afford to lose and why? 27. How would you describe the company culture in 3 words? 28. What has voluntary attrition looked like and what are people leaving for? 29. Are there any outstanding employment disputes or union matters? 30. What would change about the culture under new ownership?
7. DD Timeline Template
Standard 6-week DD timeline with gated milestones:
| Week | Phase | Key Activities | Gate / Milestone |
|---|---|---|---|
| 1 | Kickoff & Data Room | DD kickoff meeting; data room access granted; initial document review; information request gaps identified | Data room substantially populated |
| 2 | Deep Dive Begins | Financial model build; QoE analysis started; legal contract review; customer interview scheduling | Preliminary QoE adjustments identified |
| 3 | Workstream Execution | Management presentation; site visits; customer reference calls; technology deep dive; HR census analysis | Management presentation completed; site visit done |
| 4 | Analysis & Findings | Draft findings across all workstreams; red flag identification; integration complexity scoring | Draft findings memo circulated internally |
| 5 | Synthesis & Valuation Impact | Cross-workstream synthesis; valuation impact quantification; SPA markup review; closing conditions list | DD findings report draft complete |
| 6 | Report & Negotiation Support | Final DD report delivered; findings presentation to investment committee/board; support price negotiation and SPA indemnities | Final report delivered; IC/Board decision |
Timeline adjustments:
- Compressed (4 weeks): Competitive process or exclusivity pressure. Cut depth, not breadth. Focus on deal breakers.
- Extended (8 weeks): Complex carve-out, multi-jurisdiction, or regulatory approval required. Add weeks 5-6 for specialist workstreams.
8. Finding Summary with Deal Impact Quantification
For each material finding, quantify the deal impact:
| Finding ID | Workstream | Finding Description | Severity | EBITDA Impact | EV Impact | Recommended Action |
|---|---|---|---|---|---|---|
| F-01 | Financial | [Description] | Deal Breaker / Material / Manageable / Noted | $___M | $___M | [Action] |
| F-02 | Commercial | [Description] | $___M | $___M | [Action] | |
| F-03 | Legal | [Description] | $___M | $___M | [Action] |
Impact quantification methodology:
- EBITDA impact: Annual recurring impact on adjusted EBITDA (positive or negative).
- EV impact: EBITDA impact x deal multiple (e.g., $1M EBITDA hit x 8x multiple = $8M EV impact).
- One-time costs: Integration or remediation costs not reflected in EBITDA (deducted from EV separately).
Output Template
## Due Diligence Report: [Target Company Name]
**Date**: [Date] | **Transaction Type**: [Buy-side / Sell-side]
**Target**: [Company] | **Industry**: [Industry] | **Revenue**: $[X]M | **EBITDA**: $[X]M
**Deal Thesis**: [One-sentence strategic rationale]
### Executive Summary
Due diligence on [Target] identified [N] findings: [X] deal breakers, [Y] material issues,
[Z] manageable items, and [W] noted items. Adjusted EBITDA is $[X]M vs. reported $[Y]M,
a [Z]% reduction driven by [key adjustments]. Net debt is $[X]M. Integration complexity
is scored [X/5] ([Low/Moderate/High/Very High]). The deal [remains viable with adjustments /
should proceed with caution / should not proceed] based on the findings below.
### Quality of Earnings Summary
| Item | Amount ($M) | Notes |
|---|---|---|
| Reported EBITDA | $___M | As per management accounts |
| Non-recurring expense add-backs | +$___M | [Detail] |
| Non-recurring revenue subtractions | -$___M | [Detail] |
| Owner / related-party adjustments | +$___M | [Detail] |
| Accounting normalizations | +/-$___M | [Detail] |
| Pro forma / run-rate adjustments | +/-$___M | [Detail] |
| **Adjusted EBITDA** | **$___M** | **[X]% vs. reported** |
### Net Debt Bridge
| Item | Amount ($M) |
|---|---|
| Funded debt | $___M |
| Lease liabilities | $___M |
| Other debt-like items | $___M |
| Less: Cash | ($___M) |
| **Net Debt** | **$___M** |
### Working Capital Analysis
| Component | Normalized Level ($M) | Peg Mechanism | Variance to Peg |
|---|---|---|---|
| [Component] | $___M | [Trailing X-month avg] | $___M |
### Commercial DD Summary
- **Market**: [TAM/SAM/SOM validated? Growth rate confirmed?]
- **Customer concentration**: Top 5 = [X]% of revenue. [Assessment]
- **Competitive moat**: [Assessment — strong/moderate/weak with evidence]
- **Revenue durability**: [Recurring %, contract length, retention rate]
### Findings Register
| ID | Workstream | Finding | Severity | EBITDA Impact | EV Impact | Action |
|---|---|---|---|---|---|---|
| F-01 | [WS] | [Finding] | [Severity] | $___M | $___M | [Action] |
| F-02 | [WS] | [Finding] | [Severity] | $___M | $___M | [Action] |
### Integration Complexity Assessment
| Dimension | Score (1-5) | Commentary |
|---|---|---|
| Systems overlap | X | [Note] |
| Geographic overlap | X | [Note] |
| Customer overlap | X | [Note] |
| Product integration | X | [Note] |
| Cultural distance | X | [Note] |
| Regulatory complexity | X | [Note] |
| People integration | X | [Note] |
| Operational integration | X | [Note] |
| **Overall** | **X.X** | **[Low / Moderate / High / Very High]** |
Estimated integration timeline: [X] months
Estimated integration cost: $[X]M ([X]% of deal value)
### Deal Breakers and Material Issues (Detail)
#### [F-XX]: [Finding Title]
- **Description**: [Detailed description]
- **Evidence**: [What was reviewed]
- **Impact**: [Quantified impact on EBITDA and EV]
- **Recommended action**: [Walk away / Price adjustment / Indemnity / Escrow / Integration plan]
### Recommendations
1. **Proceed / Do Not Proceed**: [Recommendation with rationale]
2. **Price adjustment**: Reduce offer by $[X]M based on QoE adjustments and identified risks
3. **Structural protections**: [Indemnities, escrows, earnouts, reps & warranties to negotiate]
4. **Integration priorities**: [Top 5 Day 1 / Week 1 / Month 1 actions]
### Cross-References
- Valuation analysis: See `valuation` skill output for DCF, comps, and precedent transactions
- Financial model: See `financial-modeling` skill output for detailed projection model
Quality Checks
- DD scope explicitly defined as buy-side or sell-side with appropriate focus per workstream.
- All 6 workstreams covered: Financial, Commercial, Legal, Operational, Technology, HR/Cultural.
- Quality of earnings analysis includes full adjusted EBITDA bridge with every adjustment categorized and quantified.
- Working capital normalized using trailing 24-36 month analysis with peg mechanism defined.
- Net debt bridge includes all debt-like items (leases, pensions, contingent liabilities, tax), not just funded debt.
- Customer concentration analyzed with specific revenue percentages and red flag thresholds applied.
- Competitive moat assessed across multiple moat types with evidence and sustainability rating.
- Every finding classified by severity using the four-level scale (Deal Breaker / Material / Manageable / Noted).
- Material findings quantified in terms of EBITDA impact and enterprise value impact using deal multiple.
- Integration complexity scored across all 8 dimensions with implied timeline and cost estimate.
- Management presentation includes at least 25 questions across strategy, financial, customer, operations, technology, and people.
- Data room request list organized by workstream with sufficient specificity to be sent to the target.
- DD timeline is realistic (4-8 weeks) with gated milestones and clear deliverables per week.
- Cross-references to
valuationandfinancial-modelingskills included where applicable. - Recommendations section provides clear proceed/no-proceed guidance with price adjustment and structural protections.