What is due diligence?

The term comes from Anglo-American law and literally means “required diligence”. In mergers and acquisitions and private equity, it refers to the in-depth analysis of a target company by the party about to invest.

The principle is one of caution: the buyer checks the information provided by the seller. They examine the accounts, contracts, tax position, market, teams and, increasingly, the strength of the sales engine that produces revenue.

Due diligence pursues several complementary objectives:

• identify hidden risks: financial, legal, tax, employment or commercial
• confirm the accuracy of the information provided by the seller
• validate the real value of the target and, where needed, renegotiate the price
• secure the deal through contractual protections, such as warranties and indemnities
• prepare for the post-deal period by spotting value creation levers

Good due diligence also identifies the levers to pull to grow the company once the deal is closed.

In a standard acquisition, due diligence takes place after a letter of intent is signed and before the final signing. The buyer then gets access to the target’s documents, usually gathered in a data room.

It can also take place before the letter of intent, to validate an investment thesis, or after the investment, when a fund wants to check that its growth hypothesis holds and reduce execution risk. On the sell side, it can be carried out before the sale process, in which case it is called vendor due diligence.

Each type of due diligence sheds light on one dimension of the company. Financial due diligence, the most widespread, says little about the company’s ability to keep selling. Strategic due diligence tests whether the target’s growth potential is real.

Commercial due diligence analyses in depth the commercial strength of a company: its market position, the strength of its pipeline and the reliability of its business plan. It explains the commercial mechanics behind the figures reviewed in the financial audit.

At Atscale, this analysis combines data room review, in-depth interviews with the team, from individual contributors to senior executives, and live observation of sales calls, pipeline reviews and sales leadership meetings. The methodology has been applied in more than 100 companies, at every growth stage and in every investment context. Discover the Atscale Revenue Audit, our sales audit and commercial due diligence offer.

Standard due diligence is commissioned by the buyer. Vendor due diligence is commissioned by the seller, before a disposal or a funding round. It lets the seller anticipate investors’ questions, fix weak points before a buyer finds them, back up its growth story with facts and strengthen its negotiating position.

→ Read more in our article What is a vendor due diligence (VDD)?

The process varies with the size of the deal, but there are usually five main steps:

• Scoping: defining the scope, the types of due diligence to run and the parties involved
• Opening the data room: the seller makes the documents available, often in response to a due diligence questionnaire
• Analysis and interviews: each expert reviews their scope and meets management
• Report: summary of risks, points of attention and opportunities
• Negotiation: adjusting the price, protections or deal terms

→ Each step is detailed in our article What are the steps of an M&A due diligence?

In France, as in most jurisdictions, due diligence on a target is not a legal obligation in a company sale. It is carried out at the acquirer’s initiative, and the acquirer sets its scope. It is still strongly recommended, and almost systematic as soon as professional investors are involved. Without due diligence, the acquirer buys on the sole basis of the seller’s statements.