What a buyer’s advisers actually test, what can still be changed twelve and twenty-four months out, and what it costs to leave it until exclusivity.
The first request list usually arrives as a spreadsheet with a couple of hundred lines on it. Monthly figures for three years. Revenue by customer. Margin by product. Every adjustment to profit, with the evidence behind it. A fortnight later, the questions start coming back on the answers.
By that stage the business has typically signed heads of terms, and preparation for due diligence begins in earnest. It is around eighteen months too late. Due diligence does not examine the business you intend to become. It examines the one you have been running, using the records your team kept while they were busy doing something else.
The work that determines how that goes is almost entirely historic, and almost all of it can be done in advance.
What financial due diligence actually tests
Financial due diligence is not a review of whether your statutory accounts have been properly prepared. A buyer’s advisers are answering a narrower and more commercial question: how much of last year’s profit will still be there next year, under new ownership, and without the founder in the building.
Everything on the request list serves that question:
- Maintainable earnings. Monthly figures going back two to three years, with every adjustment to EBITDA supported by evidence rather than explanation.
- Revenue quality. Income analysed by customer, by product or service line, and by contract type, so that recurring, repeat and one-off revenue can be separated.
- Gross margin on the same cuts as revenue, and an explanation of any movement across the period.
- Working capital. Month by month rather than at the year end, because the year end is the one date in the calendar that was tidied up in advance.
- Customer and supplier concentration, and how much of the commercial relationship sits with the founder personally.
None of this can be produced retrospectively with any credibility. A data room can be assembled in a fortnight. A trading history cannot.
Why the timing works against you
Heads of terms are not usually binding on price. What they grant the buyer is a period of exclusivity, commonly eight to twelve weeks, and that changes who holds the leverage. The seller has stopped talking to other parties, professional fees are running, and the senior team knows something is happening.
From that point, every surprise moves the price in one direction. The arithmetic is unforgiving. If a buyer concludes that £100,000 of what has been presented as maintainable profit cannot be evidenced or will not recur, and the business is being valued at six times EBITDA, the reduction is £600,000 rather than £100,000. A multiple works on the way down exactly as efficiently as it worked on the way up.
The less visible cost is structure. Numbers a buyer cannot get comfortable with rarely end a transaction outright. They move consideration out of cash at completion and into deferred payments or an earn-out, they lengthen the timetable, and they widen the warranties and indemnities the seller is asked to give.
What can still be changed, and when
| When
| What can still be changed
| What it costs to leave it
|
| 24 months out | Revenue recognition policy, customer concentration, contracts put in writing, related party costs removed, a clean run of monthly accounts begun. | Nothing. This is the only window in which the history itself can be changed. |
| 12 months out | Month-end close and reconciliations, margin analysis, working capital discipline, option and R&D paperwork corrected, records organised. | Adjustments a buyer will not accept, and a management team preparing the data room instead of running the business. |
| 3 months out | Presentation: the adjustments schedule, the evidence file, the data room, the equity story. | Weak positions have to be defended rather than fixed, and specialist advice is taken under time pressure. |
| In exclusivity | Disclosure and response times only. | Price reductions at the multiple, consideration moved into earn-outs, wider warranties and indemnities. |
Twenty-four months out: what only time can fix
Some of what diligence tests is simply history, and history takes as long as it takes.
- Management accounts that reconcile to the statutory accounts. Where the year end consistently brings significant adjustments, a buyer will normalise to the statutory position and treat monthly reporting as unreliable.
- Revenue recognition applied consistently. Subscription income, multi-year licences and agency work in progress are the usual pressure points. Changing the policy while a buyer is in the room invites an obvious question.
- Customer concentration. If the largest client represents 35% of revenue, no amount of preparation alters that in a quarter. Two years of deliberate business development might.
- Contracts in writing. Significant relationships held together by goodwill and a purchase order are workable until someone is paying a multiple for them.
- Related party and personal costs. Each one becomes an add-back that has to be argued for and evidenced, item by item, usually by the founder.
Diligence tests the whole stack, not the top of it
Buyers’ advisers work downwards. They begin with the management accounts, test them against the underlying records, and form a view about how much weight the numbers will bear. That means preparation involves three distinct layers, and weakness at any one of them undermines the others.
- The books. Transactions recorded accurately and consistently, bank and control accounts reconciled, revenue and cost coded the same way every month. Everything above this layer inherits its errors.
- The management accounts. A month-end close completed within ten working days, with accruals, prepayments, deferred income and work in progress treated to a policy rather than by judgement each month.
- The interpretation. Maintainable earnings, margin by line, the adjustments and the evidence behind them, and a forecast the management team can defend under questioning.
Preparation rarely fails at the third layer. It fails at the first two, which is why the work usually has to start below CFO level and why it cannot be compressed into the weeks after heads of terms are signed.
This is also why the two services work together. HaysMac’s outsourced finance team can build and run the first two layers, providing bookkeeping and management accounts to an agreed timetable and standard. Our Fractional CFOs sit on top of that, turning reliable information into the analysis, judgement and answers a buyer will test. Businesses can take either separately, or the whole stack, depending on what is already in place.
The tax and share scheme issues that surface late
The items that hold up a transaction are often not the trading numbers at all.
- Share options. EMI valuations, notification deadlines and exercise conditions are among the most common causes of delay. Defects are expensive to correct once a buyer has found them, and they affect the people the buyer most wants to retain.
- R&D claims. Buyers will look for the evidence supporting claims already made, particularly where the benefit is material to reported profit.
- VAT and employment status. Historic treatment of contractors and freelancers, and of partly exempt or cross-border supplies, tends to be dealt with through indemnities rather than through price.
- Group structure and intercompany balances. Unwinding these sensibly takes planning, and in some cases clearances, which have their own timetable.
These are rarely deal-breakers. They are the items most likely to add weeks to a process and to shift risk onto the seller for years after completion.
Inside exclusivity: disclosure and response times
Once the process is live, the underlying answer is fixed. What remains within the seller’s control is how the information is presented and how quickly it arrives. A request list that takes three weeks to answer reads as disorganised at best, and the momentum of a transaction is harder to recover than it is to maintain.
Raise your own bad news early. An issue disclosed by the seller is a fact the buyer prices. The same issue discovered by the buyer raises a broader question about what else has not been mentioned, and that question is answered through warranties rather than conversation.
A test you can run this week
Whether or not a sale is on the horizon, work down this list and ask how long each item would take to produce properly rather than approximately.
- Three years of statutory accounts, plus a monthly profit and loss account for the last 24 months that reconciles to them.
- Revenue and gross margin by customer and by product or service line, for each of the last three years.
- A signed contract for each of the ten largest customers, with renewal and termination terms.
- Every adjustment you would want a buyer to accept to EBITDA, with supporting evidence alongside it.
- The share register, together with every option and warrant issued and the paperwork supporting them.
- All debt, leases, guarantees and licences, with their key terms.
Anything on that list that would take more than a day is worth addressing now rather than in the quarter you decide to sell. The same work makes the business easier to run in the meantime, which is the argument for doing it whether an exit is two years away or ten.
Why the wider firm matters
Preparing for diligence is not purely a finance exercise. Option paperwork is a share schemes question. Historic contractor arrangements are an employment taxes question. Group structure and intercompany balances are corporate tax questions. The negotiation itself is a corporate finance question.
An independent fractional CFO has to find specialists for each of these, coordinate them, and hope the advice joins up. A Fractional CFO working inside a full-service tax and advisory practice has those specialists along the corridor, and pulling one in for an hour is a phone call rather than a new engagement. In a process where weeks cost money, that tends to be the difference.
Frequently asked questions
What is financial due diligence?
Financial due diligence is the investigation a buyer’s advisers carry out into the historic and current financial performance of a business before completing a transaction. It focuses on maintainable earnings, the quality and concentration of revenue, margin, working capital and the reliability of management information, rather than on whether the statutory accounts have been correctly prepared.
How far in advance should you prepare for due diligence?
Twelve to twenty-four months before a likely transaction. Diligence examines two to three years of trading history, so the items that depend on time, such as consistent revenue recognition, reconciled management accounts and reduced customer concentration, can only be changed well before a buyer is in the room.
What do buyers look for in financial due diligence?
Evidence that reported profit is maintainable under new ownership. In practice that means management accounts that reconcile to the statutory accounts, revenue and margin analysed by customer and product, adjustments to EBITDA supported by documentation, working capital measured month by month, and a business that is not dependent on a small number of customers or on the founder personally.
What is a quality of earnings analysis?
A quality of earnings analysis is the part of financial due diligence that rebuilds reported profit into maintainable profit. It strips out one-off, non-recurring and non-trading items, adds back costs that will not continue under new ownership, and tests whether each adjustment is supported by evidence. It is normally the single most influential piece of work in setting the price.
Can a fractional CFO help with due diligence?
Yes. Preparation is one of the most common reasons businesses engage a fractional CFO. The work typically covers getting management reporting to the standard a buyer expects, building and stress-testing the financial model, identifying and evidencing adjustments to earnings, assembling the data room, and supporting the management team through questioning, which is a significant demand on time while the business still has to be run.
How long does due diligence take?
For a mid-market transaction, the process commonly runs alongside an exclusivity period of eight to twelve weeks, though it extends where information is slow to arrive or where issues emerge that require specialist advice. Preparation shortens it, because most delays are caused by the seller rather than the buyer.
About HaysMac’s Fractional CFO service
Our Fractional CFO service gives growing businesses access to experienced CFO-level leadership on a flexible basis, alongside the tax, share schemes, corporate finance and outsourced finance expertise of a full-service firm. It complements our outsourced finance resource, which builds and runs the reporting layer underneath.
To discuss preparing your business for a future transaction, get in touch with Elena Ramkalawon on Eramkalawon@haysmac.com or visit the contact us page here
