Financial Due Diligence Checklist for M&A

Financial due diligence on an LMM transaction typically spans three to six weeks from kickoff to final report, involving buy-side advisors (QoE provider), legal counsel, tax advisors, and the deal team's internal financial resources. Coordinating these work streams requires a structured project management approach: a unified diligence tracker, a clear information request list (IRL) submitted to the seller at kickoff, and defined milestones for each sub-team.

The information request list is often the most important document in the diligence process. A well-constructed IRL signals to the seller and their advisors that the buyer has deep sector knowledge and a specific analytical agenda. It also accelerates the process by front-loading information requests, reducing the back-and-forth that extends timelines when requests arrive piecemeal.

Revenue diligence begins with a complete revenue schedule by customer, by period, going back at least three years. From this schedule, you should be able to construct customer cohort analysis (how long has each customer been with the business and how has their spend trended), revenue bridge analysis (new customers versus expansion versus churn), and concentration analysis (what percentage of revenue is represented by the top 5, 10, and 20 customers).

Request copies of the top ten customer contracts and have legal counsel review termination provisions, assignment clauses (critical for understanding whether customer contracts survive a change of control), and pricing mechanisms. Contracts that allow customers to terminate on sixty to ninety days notice with a change of control represent a material risk that must be reflected in the purchase price or the structure of the transaction.

For every adjustment in the seller's adjusted EBITDA schedule, request supporting documentation: the expense classification in the general ledger, the underlying invoice or payroll record, and the rationale provided by the CFO. This documentation process frequently reveals adjustments that are less clear-cut than presented—expenses that recur annually but have been classified as one-time, or compensation adjustments where the replacement cost has been understated.

A complete QoE analysis will also examine items that the seller has not classified as adjustments but that a conservative buyer should consider. The most common: revenue from customers who have subsequently churned (creating a run-rate headwind), expenses that have been deferred into the post-close period (creating a cost headwind), and deferred revenue that will be recognized in the post-close period with no associated future cash inflow.

Working capital normalization is a technical but financially significant element of LMM due diligence. The purchase price in a typical LMM acquisition is stated on a cash-free, debt-free basis with a normalized working capital target. If actual working capital at closing is below the target, the purchase price is reduced dollar-for-dollar. If it is above, the seller receives the excess. Disputes over the working capital target and the closing calculation are among the most common sources of post-close litigation in LMM M&A.

The balance sheet review should also address contingent liabilities that may not be reflected in the financial statements: pending litigation, potential tax liabilities from prior year positions, environmental exposure on owned or leased property, and pension or retirement obligations for long-tenured employees. Each of these can create post-close claims against the purchase price and must be reflected in the representations and warranties negotiation.

Tax diligence on an LMM transaction typically covers the prior three to five tax years. Key areas: review of filed federal and state income tax returns, identification of any open tax years under audit or examination, analysis of transfer pricing arrangements if there are related-party transactions, and review of payroll tax compliance. For pass-through entities (S-corps, partnerships, LLCs), also examine the treatment of owner distributions and whether the business has correctly characterized expenses between wages and distributions.

The transaction structure—asset sale versus stock sale—has significant tax implications for both buyer and seller. Asset sales allow buyers to step up the tax basis of acquired assets, generating future depreciation benefits. Stock sales preserve the seller's capital gains treatment but expose the buyer to historical tax liabilities. Most LMM transactions are structured as asset sales when the buyer is a financial sponsor, but the negotiation between buyer and seller on transaction structure is often one of the most significant economic discussions in the deal.