What Happens During Due Diligence

What Buyers Actually Look For, and How to Get Through It Without Surprises

7/23/20267 min read

a group of people sitting around a table

A Realistic Walkthrough of the Most Misunderstood Phase of Selling a Business

Most business owners have heard the term "due diligence" long before they understand what it actually involves. It gets mentioned in passing, treated like a formality, a box to check between signing a letter of intent and getting a wire transfer. In reality, due diligence is where deals are made or unmade. It is the point where a buyer's enthusiasm meets your business's paper trail, and where the difference between a smooth closing and a collapsed deal usually comes down to preparation.

This is a walk through what actually happens, in roughly the order it happens, so you know what to expect and how to get through it without losing the deal or your sanity.

What Due Diligence Actually Is

Once you accept a letter of intent (LOI), the buyer moves from "I like this business" to "I need to prove this business is what it appears to be." Due diligence is the buyer's formal investigation into your company's financials, operations, legal standing, and risks before they commit real capital and sign a purchase agreement.

It is not an audit, and it is not the buyer looking for a reason to walk. Most buyers who reach this stage want the deal to work. But they are also putting their own capital, financing, or reputation on the line, and they need to verify that what you told them during the pitch matches what the records show. A good buyer's due diligence process protects both sides. It surfaces problems while there is still time to address them, structure around them, or price for them, rather than after the wire has cleared.

The Timeline

For a typical small or mid-sized business (think $1M to $15M in revenue), due diligence usually runs 30 to 90 days from LOI to closing. Several factors stretch that window:

SBA financing, which adds lender-side underwriting on top of the buyer's own review
Multiple properties, entities, or franchise relationships
Messy or informal bookkeeping that requires reconstruction
A deal team without M&A knowledge.
A buyer who is inexperienced and doesn't yet know what "normal" looks like

Sellers who have their documentation organized before the LOI is even signed routinely cut this timeline by a third. This is the single biggest lever you have.

The Core Categories of Diligence

Buyers organize their review into several work streams, often running in parallel. Here is what each one covers and what they are really looking for.

1. Financial Due Diligence

This is the heart of the process. The buyer, often working with an accountant or a quality of earnings (QoE) provider, will want:

Three to five years of financial statements (P&L, balance sheet, cash flow)
Tax returns matching those statements
A general ledger detail, not just summary numbers
Bank statements to reconcile against reported revenue
Accounts receivable and payable aging reports
Detail supporting every add-back used to calculate Seller's Discretionary Earnings (SDE)

That last point deserves emphasis. Every add-back you claimed during the marketing process, personal vehicle expenses, one-time legal fees, above-market owner salary, gets tested here. Buyers do not take add-backs on faith. They want invoices, board minutes, or a clear paper trail showing the expense was genuinely discretionary or non-recurring. A pass-through tax (PTE) election booked on the P&L but missing from the actual federal return, for example, is exactly the kind of discrepancy that gets flagged and can stall a deal while it gets explained. If your add-backs don't hold up under scrutiny, expect the buyer to come back with a lower valuation, not a friendly conversation.

Larger deals or institutional and private equity buyers will often commission a formal quality of earnings report, an independent normalization of your financials performed by a third-party accounting firm. This is more rigorous than anything a typical SMB seller has seen before, and it is becoming more common even in smaller deals as buyers get more sophisticated.

2. Legal Due Diligence

The buyer's attorney will request:

Corporate formation documents and good standing certificates
All material contracts (customer, vendor, lease, franchise, equipment financing)
Any pending, threatened, or historical litigation
Employment agreements and non-competes
Intellectual property registrations (trademarks, patents, licenses)
Permits and licenses required to operate

This is where change-of-control clauses matter. If your key customer or supplier contracts require consent to assign upon a sale, that consent needs to be sought, and it needs to happen without spooking the counterparty. Sellers who haven't reviewed their own contracts for these clauses are often surprised to find them mid-diligence.

3. Operational Due Diligence

Buyers want to understand how the business actually runs day to day, separate from what the financials say. This includes:

Org chart and key employee roles
Standard operating procedures, or lack thereof
Equipment condition and remaining useful life
Vendor and supplier relationships, including concentration
Customer concentration (if any single customer is more than 10-15% of revenue, expect real scrutiny here)
Systems, software, and any proprietary processes

This is also where owner dependency gets tested. If the business cannot function for two weeks without you personally, that is a risk buyers will price into their offer or address through a longer transition period, an earnout, or a seller note tied to performance.

4. HR and Employee Diligence

Employee census, tenure, and compensation
Benefits plans and any unfunded liabilities
Independent contractor classifications (a common landmine, especially in trades and services businesses)
Any history of employment claims or disputes

Misclassified workers are one of the more common surprises in SMB diligence. If you have people working full-time hours under 1099 status without a genuinely independent relationship, expect this to come up, and expect it to affect either price or deal structure.

5. Tax Diligence

Beyond matching tax returns to financials, buyers will look at:

Sales tax compliance across every state or jurisdiction where you have nexus
Payroll tax filings
Any open audits or unresolved notices
Entity structure and how it affects the transaction (this ties directly into whether the deal is structured as an asset sale or a stock sale)

6. Insurance and Risk

Current coverage levels and any gaps
Claims history
Whether coverage is transferable or needs to be replaced at closing

What a Buyer Is Really Trying to Answer

Strip away the checklists, and every buyer is asking three questions during diligence:

Is the business what the seller represented it to be? Do the numbers, contracts, and operations match the story told during the pitch?
What am I actually inheriting? Every liability, obligation, and risk that transfers with the business, whether it's on the balance sheet or not.
Can this business survive the transition without the current owner? This is often the real question behind dozens of smaller ones.

Where Deals Actually Fall Apart

After sitting through enough of these, a pattern emerges. Deals rarely die because of one catastrophic finding. They die from an accumulation of smaller surprises that erode trust, or from one specific issue that could have been disclosed and addressed proactively but instead came out mid-process and looked like it was hidden.

The most common deal-killers:

Add-backs that don't survive scrutiny. Not fraud, usually, just optimism that wasn't disclosed clearly upfront.
Working capital disputes that surface late. The LOI usually names a working capital target in a sentence or two. The actual mechanics, what counts as working capital, how the peg is calculated, what happens at the true-up, often aren't hashed out until diligence is well underway. By then, both sides have anchored on a number, and a disagreement over methodology can feel like a renegotiation of price, even when it isn't.
Pending litigation or a regulatory issue the seller assumed wouldn't come up.
A gap between what the seller says the business needs from them personally and what diligence reveals. If every vendor relationship, every key account, and every operational decision runs through the owner, that's a real transition risk, not just a talking point.
Buyer financing falling through. Oftentimes, there is a 3rd party to the transaction: the buyer's lender. Ensuring your business is lendable at the asking price and vetting buyer seriousness before you ever sign an LOI matters as much as everything else.
An inexperienced deal team on either side. A seller's attorney who has never handled an M&A transaction, or a buyer's advisor unfamiliar with SMB deals, can turn routine issues into standoffs. Diligence has its own rhythm and vocabulary, and a team that's learning it in real time tends to slow everything down and escalate points that a specialized deal attorney would resolve in a phone call.

None of these have to kill a deal. They kill deals when they surface as surprises instead of disclosures.

How to Get Through It Without Losing the Deal

Get your documents organized before you go to market, not after you get an LOI. A data room built in advance, with three to five years of clean financials, contracts, and corporate documents, does more to keep a deal on track than almost anything else you can control.

Know your own add-backs cold. Be able to explain, with documentation, why each one is legitimate. If you can't defend it, don't claim it.

Disclose the uncomfortable stuff early. Customer concentration, a pending lawsuit, a key employee who might leave, these are far easier to work through as known issues priced into the deal than as discoveries that make a buyer question everything else you told them.

Expect it to take longer than you think. Even well-prepared deals hit delays. Lenders ask for more documentation. Attorneys go back and forth on contract language. Build in patience, and don't let a normal delay read as a red flag on the buyer's commitment, or yours.

Keep running your business. It sounds obvious, but sellers who let performance slip during a long diligence period give buyers a reason to renegotiate. Your trailing numbers matter until the day you close.

Use an advisor who has done this before. A broker or M&A advisor who has run diligence dozens of times can anticipate what a buyer will ask before they ask it, and can keep the process moving without letting either side lose momentum, or leverage.

The Bottom Line

Due diligence is not a formality, and it is not designed to be adversarial. It is the process by which a buyer earns the confidence to actually close, and it rewards sellers who show up prepared, transparent, and organized. The businesses that move through diligence smoothly are almost never the ones with perfect numbers and zero issues. They're the ones where nothing in the data room comes as a surprise.

If you're starting to think about a sale and want to understand what your own business would look like under this kind of scrutiny, that's exactly the conversation worth having early, well before a buyer is asking the questions for you.