Rules
Part of Due diligence: the parts worth your attention
Several examinations hide inside due diligence, and each one needs a different signer
Diligence is several examinations, not one service. Which your deal needs, who is qualified to sign each, and what to verify about scope, output and liability.
Nobody sells you "diligence" as one product. You buy separate examinations, each from a different discipline, each with its own scope and its own answer on who is liable if something is missed.
Choosing well means knowing which examinations your deal needs, who is qualified to sign each one, and what you must put in writing before any starts.
What to take away
- Diligence is not one service. Buy the examinations your deal actually needs and scope each one in writing.
- The question that separates a service from a report is liability: who stands behind the finding, and are they insured to.
- A purchase of this size warrants an intermediary, an accountant and a lawyer. Two of those three are doing the diligence; the third should not be scoping it.
The examinations, and who performs each
| Examination | What it establishes | Who is qualified |
|---|---|---|
| Financial | Whether the earnings are real, recurring, and reconciled to cash | An accountant, ideally one who has worked buy-side |
| Legal | What comes attached: contracts, consents, disputes, ownership of assets | A lawyer engaged by you, not by the seller |
| Commercial | Why customers buy and what would make them stop | You, with help; rarely a service you can buy honestly |
| Technical or operational | Whether the equipment, premises, systems or licenses do what is claimed | A specialist in that trade, not a generalist |
| Tax | What the structure costs each side and what exposures ride along | Your accountant, before a structure is agreed |
The middle row is the one people try hardest to outsource and the one that outsources worst. A stranger cannot tell you why your future customers buy. What a service can do is assemble the evidence you use to work it out.
Examinations and Who Signs
Examination
- Financial
- Earnings real, recurring, cash-reconciled
- Legal
- Contracts, consents, disputes, asset ownership
- Commercial
- Why customers buy and stop
- Technical
- Equipment, premises, systems, licenses
- Tax
- Structure costs and exposures
What it establishes
- Financial
- Accountant, ideally buy-side
- Legal
- Lawyer engaged by you
- Commercial
- You, with help
- Technical
- Specialist in that trade
- Tax
- Your accountant, before structure
Who is qualified
- Financial
- Legal
- Commercial
- Technical
- Tax
What to verify before engaging any provider
Who does the work. The person in the meeting is often not the person on the file. Ask for the name, the experience, and how many similar examinations that individual has completed.
Verify Before Engaging a Provider
- Who does the workname, experience, similar examinations
- What scope excludesread exclusions paragraph first
- What output iswritten report, lender-reliable, or verbal debrief
- Whether they carry professional indemnity insurance
- Their qualification to signcheck the register
- Whether they will tell you to stop
What the scope excludes. Every engagement letter has an exclusions paragraph, and it is more informative than the inclusions. Read it first and ask what would have to happen for each excluded item to be brought in.
What the output is. A written report you may rely on, a report your lender may also rely on, or a verbal debrief with slides. These are different products, and only the first two can be relied on later.
Whether they carry professional indemnity. A finding nobody is liable for is an opinion. Ask about professional liability insurance and whether the report is issued under it.
Their qualification to sign. For financial work in the United States that usually means a certified public accountant or an equivalent professional body elsewhere. Ask which body, and check the register rather than the letterhead. For a CPA, the register is the State Board of Accountancy that issued the license, and CPAverify lets anyone check CPA licensing information provided by participating State Boards of Accountancy in one search. For the lawyer on the legal examination, the equivalent is the attorney roll kept by the state bar or the state's licensing authority where they practice.
Whether they will tell you to stop. Ask directly what they would do if the examination produced a finding that killed the deal. A provider whose fee depends on the transaction completing has an answer you should hear before you engage them.
Scoping the work so the money goes where the risk is
Diligence expands to fill any budget, so the scope has to be written before anyone starts. The order that works:
Scoping Diligence to the Risk
- List what would make you walk away
- Assign each item to a discipline
- Ask what evidence would settle it
- Set reporting sequencedeal-breakers first
- Decide where each finding lands
- List what would make you walk away.Earnings that do not reconcile to cash, a key contract that ends on a change of ownership, a license that cannot transfer. Keep it short.
- Match each item to an examination.Every deal-breaker belongs to one row of the table above, and that row names who should test it.
- Spend in proportion to the risk.The examinations that carry deal-breakers get the depth; the rest get a limited-scope review.
- Write the scope for each provider.What is examined, what is excluded, which period, and what the output is: written findings addressed to you that you, and if needed your lender, may rely on.
- Say what each finding is for.Tell every provider whether a finding would mean walking away, a lower price, a specific warranty or indemnity, or a condition before closing.
Step five is what separates diligence from research. The diligence guide sets out what a finding should lead to; a provider who is not told what the findings are for will produce a long list of observations of even weight.
What is not a diligence service
A seller's own report. Some sellers commission a review before going to market. It is useful, and it was written for them. Read it, then have your own accountant test the parts that matter. What that report is for is described in the seller preparation year.
Not a Diligence Service
What it is
- Seller's own report
- Written for them, not you
- Background-check subscription
- Confirms entity exists only
- Intermediary's assurance
- Fee depends on completion
- Valuation
- Different question, unverified inputs
Why it is not diligence
- Seller's own report
- Background-check subscription
- Intermediary's assurance
- Valuation
A background-check subscription. Useful for confirming an entity exists and who is registered to it. Not an examination of anything.
An intermediary's assurance. The intermediary runs the process. Their fee generally depends on completion, which is exactly the wrong incentive for the person testing whether the deal should complete; the business brokers page explains why.
A valuation. A different question entirely, run on inputs diligence has not yet verified. The valuation methods guide sets out what it can and cannot answer.
The one thing to insist on
You are entitled to rely on written findings addressed to you. Everything else is negotiable. Without it, you paid for a conversation, and a conversation cannot be produced later.
That matters when a warranty claim turns on what was known before closing, or when a lender asks what your accountant actually examined. An examination with scope, author, and reliance written down is worth more than a broader one with none of those.
