Before buying a company, bringing in an investor or closing a merger, there is one essential question worth answering: is the company really what it appears to be? Due diligence is the process that answers it. It is a structured investigation that lets a buyer or investor understand the true state of a business before signing, so the decision rests on verified information rather than assumptions.
This guide explains exactly what due diligence is, what it is for, what types exist and how the process unfolds.
What is due diligence?
Due diligence is a thorough analysis of the situation of a company, an asset or a project, carried out ahead of a sale, merger or investment. The term captures its purpose well: acting with the care expected of anyone making an important decision, verifying reality rather than simply trusting what the other party states.
Two common misconceptions are worth clearing up:
- The first is confusing it with an audit: a financial audit is a regulated examination that follows a standard methodology and focuses on the financial statements, whereas due diligence is a bespoke analysis of a specific transaction, with a scope defined by what the parties need and reaching well beyond the accounts.
- The second is assuming it is mandatory: strictly speaking it is not (no general rule requires it, apart from specific compliance situations), but in practice no serious professional transaction closes without it, because it is the best tool for avoiding buying blind.
What it is for: the objectives of due diligence
The ultimate aim of due diligence is to reduce the uncertainty of the person about to buy or invest, by bringing to light whatever does not appear in an initial exchange of information. From there, it serves four specific functions worth keeping in mind:
- Validate the information provided by the seller, checking that the accounts, contracts and documents reflect reality.
- Detect hidden risks, from undeclared debts to pending litigation or penalties.
- Adjust the price when the findings justify it, revising the initial offer downwards or making it conditional.
- Strengthen the contract, translating the risks identified into guarantees, representations and warranties and protective clauses for the buyer.
All of this rests on one principle: throughout the process, the seller provides the information required to carry out the review, usually under a confidentiality agreement and in accordance with the commitments agreed between the parties.
Types of due diligence
There is no single due diligence, but rather several areas of review that, in a serious transaction, are handled in parallel by different specialists. The exact scope depends on the company and the type of deal, but these are the most common forms, each covered in its own guide.
Financial due diligence
It analyses the real economic health of the business: the quality of EBITDA, the debt structure, working capital needs and the reliability of the accounts. It is usually the basis on which the price of the deal is built.
Legal due diligence
It reviews the company’s legal situation: corporate structure, contracts, ownership of assets, litigation, regulatory compliance and intellectual property. It is the one that confirms the company truly owns what it is selling and carries no legal contingencies.
Tax due diligence
It focuses on tax matters: compliance with obligations, possible contingencies with the authorities, the deductions applied and the tax years still open to review. It almost always goes hand in hand with the financial and legal reviews.
Labour due diligence
It examines the workforce, contracts, applicable collective agreements, social security contributions and any latent employment liabilities. It carries particular weight when the team is the main asset and when the transaction involves a transfer of undertaking.
Real estate due diligence
It checks the ownership and encumbrances of the properties, their planning status, licences and the state of any leases. It is decisive when the main asset of the deal is a property or a portfolio of them, an area closely linked to real estate investment.
Other types: commercial, technological and environmental
Alongside the above there are more specific reviews. The commercial one studies the market, the customer base and any over-reliance on a few clients; the technological one analyses systems, cybersecurity and software ownership; and the environmental due diligence assesses environmental risks, while the ESG review broadens the analysis to include environmental, social and governance factors, an area that is gaining importance with European sustainability regulations. .
The phases of the due diligence process
Due diligence is not a single act but an orderly process that begins once the parties have already agreed the broad lines of the deal. Although its complexity varies with the size of the transaction, the usual path follows a recognisable sequence.
It normally starts with the signing of a confidentiality agreement (NDA), which protects sensitive information, and a letter of intent (LOI), in which the buyer sets out a non-binding offer and, as a rule, a period of exclusivity. From there, the company under review sets up a data room, now almost always a secure virtual repository where it deposits, in an organised way, all the documentation the advisers will examine. The data room is the centrepiece of the process: a well-ordered space speeds up the analysis and reduces the room for surprises.
With the documentation available, the team of advisers carries out the analysis, raises queries and requests additional information (the questions and answers, or Q&A, phase) until confirming that the data matches the reality of the business. The process ends with a report that ranks the findings by their severity and flags the most serious as red flags. Those conclusions do not sit in a drawer: they feed directly into the sale and purchase agreement (the SPA), where they take the form of price adjustments, guarantees or amounts held back until certain risks are cleared.
When it is needed
Although due diligence is mostly associated with buying companies, it is advisable whenever an important decision depends on the state of a company or an asset. The most frequent scenario is the sale of companies and M&A transactions, where the buyer checks, before signing, that the business matches what was agreed. It is also key in the entry of investors or new partners, in financing operations, in mergers, restructurings and joint ventures, and in real estate investment.
A case with its own particularities is investing or setting up in Andorra. For the investor from Spain or France who decides to operate in the Principality, the review must be adapted to the Andorran framework (foreign investment rules, registers and authorisations), because the criteria of the home country do not apply in the same way on the other side of the border. Each of these situations is dealt with in the guide on when legal due diligence is needed, which you can turn to for more detail.
How long it takes, how much it costs and who carries it out
The duration has no single timeframe: it depends on the size and complexity of the company and, above all, on how orderly the documentation is; in mid-sized transactions it is usually completed in a few weeks, within the agreed period of exclusivity, and it can stretch to a month or more when the information is scattered.
As for the cost, each party usually bears its own advisers: the buyer pays for the acquisition review and the seller, if commissioned, for theirs. It is carried out by specialised teams from the different disciplines, often coordinated by a lawyer who gives coherence to the whole.
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It is worth pausing on a nuance that often goes unnoticed: due diligence is not always commissioned by the buyer. Increasingly common is vendor due diligence, the review the seller requests before opening the process in order to detect and fix the weak points of the company in time; this way they reach the negotiation with the documentation in order and from a stronger position. An example illustrates the value of all this: if the review uncovers an unrecorded debt or a contract with a change of control clause that can be terminated on sale, that finding immediately translates into a price reduction or a specific guarantee; spotting it in time is what prevents overpaying or inheriting a problem.
Due diligence and valuation: two parts of the same decision
Due diligence should not be confused with company valuation, although the two go together. Company valuation estimates how much the business is worth and underpins the initial offer, whereas due diligence verifies whether that value holds up when tested against reality. Understanding both and preparing them in advance is what makes it possible to approach any transaction, whether buying, selling or investing, with confidence and without the negotiation turning into a rearguard defence.
