Due diligence is where deals are won or killed. It's the analytical process that sits between signing a letter of intent and closing a transaction – and it's where junior bankers spend a significant chunk of their time on live deals. If you want to talk credibly about what investment bankers actually do day-to-day, you need to understand DD.
What Is Due Diligence?
Due diligence is the comprehensive investigation of a target company conducted by (or on behalf of) a potential acquirer before completing an acquisition. The purpose is to verify the target's financial performance, identify risks, validate assumptions, and ensure the buyer knows exactly what they're getting.
Think of it as the corporate equivalent of a building survey before buying a house – except the house has 10,000 rooms and the surveyor is a team of bankers, accountants, lawyers, and consultants working around the clock.
Types of Due Diligence
Financial Due Diligence: The core workstream. A detailed analysis of the target's historical financial performance, quality of earnings, working capital normalisation, debt-like items, capital expenditure, and cash flow. Usually led by a Big Four accounting firm on behalf of the buyer. Key outputs include: adjusted EBITDA (normalised for one-time items), sustainable run-rate earnings, net debt and debt-like items, and normalised working capital.
Commercial Due Diligence: Assesses the target's market position, competitive dynamics, customer concentration, end-market growth, and commercial sustainability. Often conducted by strategy consultancies. Key question: will the target's revenue and earnings be sustainable or growing post-acquisition?
Legal Due Diligence: Reviews contracts, litigation exposure, intellectual property, employment arrangements, and regulatory compliance. Identifies legal risks that could affect valuation or require specific indemnification in the sale agreement.
Tax Due Diligence: Analyses the target's tax position, identifies potential tax liabilities, and evaluates the tax efficiency of different deal structures.
Operational Due Diligence: Assesses operational infrastructure – IT systems, supply chain, manufacturing capacity, facilities. Particularly important for PE firms planning operational improvements.
Environmental, Social, and Governance (ESG): Increasingly important. Assesses environmental liabilities, ESG compliance, and social/governance risks. Required by most institutional investors.
'What is quality of earnings?' This is the centrepiece of financial due diligence. It analyses how much of the target's reported EBITDA is sustainable, recurring, and cash-generating. It identifies add-backs (legitimate one-time costs), adjustments (normalisation for unusual items), and red flags (aggressive accounting, customer concentration, related-party transactions). If you're asked about DD, mention quality of earnings – it shows you understand what actually happens.
What Do IB Analysts Do During Due Diligence?
On the sell-side (advising the seller), junior bankers:
Prepare the data room: Compile and organise thousands of documents – financial statements, contracts, customer data, employee information, IP documentation – in a virtual data room (Intralinks, Merrill DatasiteOne). This is extremely time-consuming and detail-oriented.
Draft management presentations: Help management prepare presentations for potential buyers during the management meeting phase.
Respond to buyer questions: Coordinate responses to buyer information requests, working with the client's finance team and legal counsel.
Track the process: Manage timelines, monitor bidder engagement, and report to senior bankers on the status of each buyer's diligence progress.
On the buy-side (advising the buyer), junior bankers:
Analyse the CIM: Tear apart the Confidential Information Memorandum, stress-test management projections, and build an independent financial model.
Coordinate diligence workstreams: Work with the accounting firm (financial DD), lawyers (legal DD), and consultants (commercial DD) to ensure all workstreams are progressing.
Build the investment case: Synthesise findings into an investment recommendation for the buyer's board or investment committee.
'What's your understanding of what a first-year analyst actually does on a deal?' This is a common fit question. The honest answer includes significant data room preparation, financial model building and updating, presentation drafting, and administrative coordination. Don't romanticise it – interviewers respect candidates who understand the reality of the role.
Key Concepts
Data Room: A secure virtual repository containing all due diligence documents. Sellers control access, track which documents each buyer opens, and manage information flow. The data room is the central hub of any DD process.
Management Meetings: Structured meetings where the target's management team presents to potential buyers and answers questions. A critical part of the buyer's assessment of the team they'll be acquiring.
Red Flags: Issues identified during DD that could affect valuation or kill the deal entirely. Common red flags include: customer concentration (one customer = 40%+ of revenue), declining margins not explained by one-time factors, related-party transactions, pending litigation with material exposure, and environmental liabilities.
Material Adverse Change (MAC) Clauses: Contract provisions allowing the buyer to walk away if the target experiences a significant deterioration between signing and closing. What constitutes a MAC is heavily negotiated.
Common Interview Questions
'Walk me through the DD process.' After signing a letter of intent, the buyer and their advisors conduct financial, commercial, legal, tax, and operational due diligence. Financial DD focuses on quality of earnings, working capital, and debt-like items. The findings inform final valuation, purchase price adjustments, and the sale and purchase agreement terms.
'What would you look for in financial due diligence?' Quality of earnings (are reported profits sustainable?), normalised working capital (what level should be included at closing?), net debt and debt-like items (unfunded pensions, deferred revenue, operating leases), and CapEx requirements (maintenance vs growth).
'What's the difference between a CIM and a data room?' The CIM is a marketing document prepared by the sell-side advisor to introduce the target to potential buyers. It's promotional. The data room contains the raw underlying documents (contracts, financials, legal agreements) that buyers analyse during formal due diligence. CIM first, then data room access for serious bidders.
Our AI tutor covers due diligence, M&A process, and deal-related interview questions.
Try it free.
