Due diligence is one of the most critical stages of any business sale. For many SME owners, it can also be the most challenging. The process involves a comprehensive investigation of financial, legal, operational, and commercial aspects of the business. Buyers use it to confirm the information provided, uncover risks, and justify the final deal structure. Sellers who are unprepared can find value eroded, terms tightened, or even the deal collapsing.
Financial Due Diligence
The financial review is usually the most detailed part of the process. Buyers will expect to see full management accounts, audited financials where available, tax filings, and forecasts. The focus is on verifying the quality of earnings, ensuring that reported profits are sustainable, and testing the accuracy of forecasts.
Adjustments for normalisation are common, such as removing owner-specific costs, one-off expenses, or non-core income.
Working capital is also heavily scrutinised, with buyers calculating whether the business can support itself without additional funding post-completion.
Debt and debt-like items, including tax liabilities, leases, and pensions, are examined closely because they can directly reduce the purchase price.
Legal Due Diligence
The legal review assesses whether the business has clear ownership of assets and is compliant with relevant regulations.
Buyers will want to see incorporation documents, shareholder agreements, customer and supplier contracts, intellectual property registrations, and employment agreements.
Areas such as GDPR compliance, health and safety, and environmental regulations are increasingly prominent in UK SME transactions.
Commercial Due Diligence
Commercial due diligence tests the strength of the market and the business’ position within it. Buyers may commission independent research into customer satisfaction, competitor positioning, and growth prospects.
Customer concentration is often a key concern; if too much revenue comes from a small number of clients, buyers will discount the valuation to reflect this risk.
Equally, reliance on particular suppliers or distribution channels can be flagged as a vulnerability.
Operational Due Diligence
Operational reviews focus on whether the business has the systems, processes, and infrastructure needed to deliver its forecasts. This includes supply chain resilience, IT systems, scalability, and reliance on key staff.
Businesses that depend too heavily on the owner for day-to-day operations may be penalised. Buyers want to see documented processes and a management team capable of running the company independently.
Tax Due Diligence
Tax is a specialist area of due diligence that can significantly impact deal value. Buyers will check compliance with VAT, PAYE, corporation tax, and any reliefs claimed.
HMRC investigations or disputes can raise red flags. Structures such as group arrangements, overseas operations, or complex shareholding setups receive additional scrutiny.
Unexpected tax exposures are usually deducted directly from the purchase price or covered by warranties and indemnities.
How Due Diligence Affects the Deal
Issues uncovered during due diligence often lead to price adjustments, stricter terms, or additional protections demanded by the buyer.
Common mechanisms include retention of part of the consideration, expanded warranty coverage, or earn-out structures tied to future performance.
For sellers, a lack of preparation can result in significant value erosion, even if headline terms initially look strong.
Preparing for Due Diligence
Sellers can protect value by conducting vendor due diligence before going to market. This involves identifying potential issues in advance, resolving them where possible, and presenting the business in a clear, organised manner.
Steps include preparing a well-structured data room, ensuring contracts are up to date, reconciling tax and accounting records, and documenting key operational processes.
The more prepared a seller is, the smoother the process and the stronger the negotiating position.
We’ve pulled together a brief article on what to expect from a due diligence exercise here
Final Thoughts
Due diligence is not just a box-ticking exercise. It is the buyer’s opportunity to validate their assumptions and protect themselves against risk.
For SME owners, understanding the process and preparing thoroughly is essential to protect value and avoid unpleasant surprises.
