Mastering Due Diligence

1 What is due diligence?

Due Diligence (DD) literally means “due diligence” and refers to the systematic review of a company prior to its acquisition. The goal is to obtain as complete a picture of the company as possible before signing the purchase agreement—and to uncover hidden risks.

When does due diligence take place?

Due diligence takes place after the LOI (Letter of Intent) is signed and before the purchase agreement. In the LOI, you typically secure an exclusivity period during which you can review the company without the seller negotiating with other prospective buyers at the same time.

• Typical timeframe: 4–8 weeks, depending on complexity

• Data room: The seller provides you with documents in a (virtual) data room

• Q&A process: You clarify any open questions in writing or through discussions with the seller

2 DD Scope: Small vs. Large Transactions

The scope of due diligence depends largely on the size of the transaction and the type of company. You don’t always do everything—and you shouldn’t.

Small transactions (purchase price under approximately €2 million)

For smaller deals, conducting due diligence across all areas of the company is often neither proportionate nor financially feasible. Instead, with expert support, you should focus on the key deal breakers:

• Financial review – Do the numbers add up? Are the financial statements accurately prepared? Are there any indications of improper accounting, undisclosed liabilities, or inflated results?

• Tax review – Are there any outstanding back taxes, ongoing tax audits, or tax risks that will be transferred to the buyer?

• Legal review – Are there any ongoing legal disputes, critical contract clauses (e.g., change-of-control clauses in customer contracts), or liability risks?

The focus is on the question: Is there anything that should cause the deal to fall through? Not on a comprehensive review of all areas of the business.

Larger Transactions (purchase price of approximately €2 million or more)

For larger deals, due diligence becomes significantly more extensive. Here, we refer to various DD streams (areas of review), each of which is conducted by specialized advisors:

Always recommended Depending on the type of company Rather rare

3 The Three Core Areas of DD

Regardless of the transaction size, there are three essential areas to review in every business acquisition. Here’s what you need to look for in each area.

Financial Due Diligence: Reviewing the Numbers

Financial due diligence is the most important due diligence stream—it’s part of every transaction. The goal is to ensure transparency regarding the company’s financials.

• Review historical figures —consistently prepare the income statement, balance sheet, and cash flow statement for the last 3 years

• Normalize EBITDA —adjust for one-time items, owner’s compensation, and personal expenses (→ basis for the valuation)

• Analyze working capital —Is current assets at a normal level?

• Review net debt —What financial liabilities exist? Do they align with the price bridge?

• Question the projected figures —Are the seller’s assumptions about the future realistic?

Tax DD: Identifying Tax Risks

A tax audit ensures that no past tax liabilities are passed on to you as the buyer.

• Review tax assessment notices —Are all notices final, or are there still audits pending?

• Ongoing tax audits – Are there any pending or announced audits by the tax authority?

• Sales Tax Risks – Correct payment, input tax deduction, intra-Community supplies

• Structural optimization – For larger deals: Is the corporate structure tax-efficient?

Legal Due Diligence: Identifying Legal Risks

The legal due diligence uncovers liability risks and contractual pitfalls.

• Articles of Incorporation and Commercial Register – Are the ownership structures accurate? Are there preemptive rights or consent requirements?

• Key Contracts – Review customer, supplier, and lease agreements for termination rights and change-of-control clauses

• Employment Contracts – Special agreements with key employees, severance provisions, works council

• LegalDisputes – Ongoing or impending lawsuits, administrative proceedings

• Intellectual Property Rights – Trademarks, patents, licenses – do they belong to the company?

4 Red Flags and Deal Breakers

Not every finding in due diligence is automatically a reason to call off the deal. But there are warning signs you need to take seriously—so-called red flags. And there are findings that should actually cause the deal to fall through: deal breakers.

Financial Red Flags

• Inconsistent figures —the income statement, balance sheet, and tax returns don’t match

• Unexplained fluctuations —sudden spikes in revenue or drops in margins without a clear explanation

• Undeclared Liabilities – Loans, guarantees, or pension commitments not listed on the balance sheet

• High Accounts Receivable – Many overdue invoices may indicate payment problems on the part of customers

• Inflated EBITDA – Costs were shifted to other periods or revenue was recognized early

Legal red flags

• Pending lawsuits – Especially those involving high amounts in dispute or claims for damages

• Change-of-control clauses – Key customer or lease agreements may be terminated in the event of a change in ownership

• Missing Permits – The company is operating without the required licenses or permits

Tax Red Flags

• Ongoing tax audit – The tax authority is still conducting an audit and could demand back payments

• Hidden Profit Distributions – The owner has run personal expenses through the company that were not properly accounted for tax purposes

• Potential Back Taxes – There are indications of tax liabilities that could be passed on to the buyer

5 Organizing DD in a Practical Way

How you actually conduct due diligence depends on the size of the transaction. But the basic process is always similar.

Step by Step

1. Define the scope of due diligence —which areas are relevant for this transaction? (see table above)

2. Engage advisors – Involve a tax advisor, attorney, and, if necessary, other specialists

3. Request documents – Send a document request list to the seller

4. Review the data room – Systematically go through the documents and document any outstanding issues

5. Q&A process – Send a written list of questions to the seller; document the responses

6. Prepare the due diligence report – Summarize the results; assess red flags and deal breakers

7. Re-evaluate the purchase price – Incorporate findings into the valuation (adjust the price range)

What advisors do you need?

There are specialized advisors for each due diligence stream. You don’t need a separate one for every area—for small deals, a tax advisor often handles the financial and tax review, and an attorney handles the legal review.

• Tax Advisor / Certified Public Accountant – Financial DD and Tax DD

• Attorney (M&A specialist) – Legal due diligence, review of the purchase agreement

• M&A Advisor / Transaction Services – For larger deals: Coordination of the entire due diligence process

• Specialist Advisors —IT/Tech, ESG, Insurance—only as needed and for larger transactions

Costs of Due Diligence

Costs vary greatly depending on the scope:

• Small deals (< €2 million): Approx. €5,000–50,000 for tax advisors + attorneys

• Medium-sized deals (€2–10 million): Approx. €20,000 – 250,000 for multiple due diligence streams

• Large deals (> €10 million): Starting at €150,000 and often more for comprehensive due diligence with many due diligence streams

These costs are part of the transaction costs and should be factored into the budget from the outset.