What due diligence is and how to prepare for it

Due diligence is the full review a buyer carries out on a company —with its financial, legal and tax advisers— before signing the sale and purchase agreement, to verify that the seller's information is accurate and to identify contingencies that could affect the price. It takes place after the letter of intent (LOI) and within the agreed exclusivity period, which usually runs for 60 to 90 days; in SME deals the whole process is normally completed in a few weeks and covers the financial, legal, tax, employment, corporate and operational areas of the business.

For many owners of industrial SMEs it is the most feared stage of a sale: the moment when the buyer examines in detail everything sitting beneath the profit and loss account. The mergers and acquisitions market in Spain closed 2024 with 3,473 deals worth €95,791 million in aggregate, 8% more deals than the year before (TTR Data, 2024); behind every one of those deals there is a due diligence exercise that either holds it together or derails it. At Tecnocim Innova we run due diligence processes on both the buy side and the sell side, so understanding what it is and, above all, how to prepare for it in advance is the difference between closing at a good price and watching that price evaporate at the negotiating table.

What is due diligence?

Due diligence (literally, "the diligence that is owed") is the investigation and analysis a potential buyer of a company carries out to verify that the information provided by the seller is accurate, complete and a fair reflection of the business. In practice it is a full review ahead of signing the sale and purchase agreement: the buyer goes through the accounts, the contracts, the tax and employment obligations, the litigation, the assets and any risk that could affect the value of what is being bought.

The purpose is twofold. First, to confirm the value of the business and validate the assumptions on which the offer was built. Second, to identify contingencies —hidden debts, tax risks, problematic contracts— that justify a price adjustment, a demand for guarantees or, in serious cases, the withdrawal of the offer.

Due diligence is not a formality. Its conclusions feed straight into the sale and purchase agreement (the SPA, Sale and Purchase Agreement), where they take shape as the representations and warranties the seller gives the buyer, as indemnity clauses and, frequently, as price adjustments or as amounts held back until certain risks are cleared.

What is it for and when does it happen?

In a well-run sale process, due diligence occupies a specific slot. These are the usual stages of an M&A deal in an SME:

1. Contact and confidentiality: the parties sign a non-disclosure agreement (NDA) before sharing sensitive information.
2. Preliminary information: the seller hands over an information memorandum or teaser with the essential facts about the business.
3. Letter of intent (LOI): the buyer puts a non-binding offer in writing with a price range and the main conditions, and includes an exclusivity clause that usually runs for 60 to 90 days.
4. Due diligence: the review period opens, normally with exclusivity for the buyer.
5. Negotiating the contract (SPA): the due diligence findings are translated into clauses, warranties and, where applicable, a price adjustment.
6. Signing and closing: the transaction is executed, usually before a notary.

Due diligence therefore takes place after there is a preliminary agreement on price but before the final signature. It is the moment when the buyer, now with skin in the game, checks that what it has agreed to pay matches the reality of the company.

Are you about to sell or buy a company? The M&A team at Tecnocim Innova runs buy-side due diligence and prepares selling companies to come through it without surprises. See our due diligence service.

What types of due diligence are there?

There is no single due diligence, but several areas of review that, in a serious transaction, are handled in parallel by different specialists. These are the main ones:

Financial due diligence

This is the core of any deal. It goes well beyond reading the annual accounts: the buyer wants to understand the quality of earnings. One of the central tasks is to strip out of EBITDA any non-recurring items or owner's expenses that a new owner would not take on, to arrive at a normalised EBITDA that reflects the real capacity to generate cash. The analysis also covers net financial debt and working capital requirements, two variables that feed straight into the price under the cash free, debt free structures common in M&A.

Legal and tax due diligence

The legal review verifies that the company really owns what it is selling, that its contracts are in order and that it is not carrying litigation capable of eroding value. One critical point is change of control clauses: contracts with customers, banks or suppliers that can be terminated if ownership of the company changes. On the tax side, it is worth remembering that tax debts stay with the company: a buyer of the shares in a Spanish company takes on the risk of tax contingencies from years that are not yet time-barred. That is why the review looks closely at inspections by the Spanish Tax Agency (AEAT), the deductions claimed and correct filing under the Impuesto sobre Sociedades (Spanish corporate income tax).

Employment due diligence

The buyer analyses the structure of the workforce, whether Spanish Social Security contributions have been paid correctly, the existence of latent employment liabilities and the application of the collective bargaining agreement. It is worth remembering that, where the deal amounts to a transfer of an undertaking, article 44 of the Estatuto de los Trabajadores (the Spanish workers' statute, Real Decreto Legislativo 2/2015, 2015) imposes the automatic transfer of the workforce: the buyer inherits the employment relationships and, for three years, is jointly and severally liable with the seller for employment obligations that arose before the transfer. That turns any hidden employment liability into a direct risk for the acquirer.

Why do deals fall apart during due diligence?

Most of the problems that surface in a due diligence are not fraud: they are oversights, poor document management and risks the seller never had any reason to formalise. The most frequent findings that destroy value or stall deals are:

• Unreliable accounts, or accounts that mix personal spending with company spending, which stops the buyer trusting the figures.
• Assets without clear title, such as property, trade marks or machinery that are not properly registered in the company's name.
• Tax contingencies from poorly documented deductions or from years still open to inspection.
• Hidden employment liabilities, from bogus self-employed contractors to debts with the Tesorería General de la Seguridad Social, the Spanish Social Security treasury.
• Excessive dependency on a handful of customers or on the founder, which casts doubt on the continuity of the business after the sale.
• Key contracts that cannot be transferred or that carry change of control clauses triggered by the deal.

Every one of these findings has the same effect: the buyer perceives more risk, demands more guarantees and, almost always, offers less money. The good news is that nearly all of them can be avoided with preparation.

How to prepare for due diligence: the data room

If you are on the sell side, the best way to protect your price is to reach due diligence with your homework done. The central instrument is the data room: a repository, today almost always virtual, where all the documentation the buyer will need to review is organised in a structured and secure way. A well-prepared data room signals professionalism, speeds up the process and leaves less room for surprises.

These are the blocks of documentation worth having ready:

• Corporate: deeds, up-to-date articles of association, register of shareholders, minutes of the governing bodies.
• Financial: audited annual accounts for recent years, trial balances, bank reconciliations, a breakdown of the debt.
• Tax: returns for the main taxes, proof of payment, inspection records if there are any, documentation for the deductions claimed.
• Employment: list of employees, contracts, applicable collective agreement, contribution records, position with the Spanish Social Security.
• Contracts: agreements with main customers and suppliers, financing agreements, leases, licences.
• Assets and industrial property: title to property, machinery, registered trade marks and patents.
• Litigation and contingencies: open proceedings, claims, guarantees granted.

Vendor due diligence: getting ahead of the problems

A practice that is increasingly common in deals of a certain size is vendor due diligence (VDD): the seller commissions an independent review of its own company, before opening the process, as if it were the buyer. The aim is to spot and, as far as possible, fix the problems before the other side finds them. The advantages are clear: the seller controls the timing, avoids surprises that erode trust, keeps more negotiating power against discounts or price retentions and brings a credible report that speeds the process up. For a family business that sells once in its history, getting ahead in this way can be the difference between an orderly sale and a defensive negotiation.

How long does due diligence take?

There is no single timeframe, because it depends on the size and complexity of the company, on the number of areas to review and, above all, on how well ordered the documentation is when it arrives. As a guide, in SME deals a full due diligence usually runs over several weeks from the moment the buyer gains access to the data room, within the exclusivity period agreed in the letter of intent. A company whose information is well structured can complete the process quickly; one with scattered documentation, unclean accounts and assets without title can drag it out for months and lose the buyer along the way. Preparing in advance does not only reduce risk: it shortens the timetable and keeps the deal moving, which is exactly when transactions close.

Frequently asked questions about due diligence

Who pays for the due diligence?

As a general rule, each side bears the cost of its own advisers: the buyer pays for the buy-side due diligence and the seller, where applicable, for the vendor due diligence. That split can nonetheless be negotiated as part of the general terms of the deal.

Is due diligence compulsory?

It is not a legal obligation, but in practice no professional company sale closes without it. For the buyer it is the essential tool for avoiding a blind purchase; for the seller, preparing it well is the best defence of the price.

What is the difference between due diligence and business valuation?

They are separate and complementary stages. Valuation estimates what the company is worth and underpins the initial offer; due diligence verifies whether that valuation stands up against reality. To understand how the starting point is calculated, see our guide to what my company is worth and the valuation methods.

Does a family business need due diligence?

Yes, and often more than others. Family businesses frequently mix personal and business expenses, hold assets in the family's name and take decisions without formalising them. Putting all of that in order in advance is essential, particularly when the sale is being considered as an alternative to succession within the family. If you are weighing up the whole process, we recommend reading our guide on how to sell a company in Spain.

What happens if the due diligence finds problems?

It does not always mean the deal collapses. Findings can translate into a price adjustment, into specific guarantees (representations and warranties in the contract), into part of the price being held back or into conditions that have to be met before closing. The key is to handle them with an adviser who knows how to negotiate the balance between risk and price.

Next step: prepare your deal with confidence

Due diligence is the moment of truth in any company sale. For the buyer, it is the assurance that it is paying for what it actually receives. For the seller, it is the test that decides whether the agreed price holds or is cut back finding by finding. In both cases the outcome depends on one thing: preparation.

At Tecnocim Innova we support industrial and family businesses through the entire sale process, from valuation to closing. We run buy-side due diligence and prepare selling companies —with a data room, vendor due diligence and early correction of contingencies— so that they reach the negotiation from a position of strength.

Do not let the due diligence set the price of your company. Talk to our M&A team and prepare your deal properly.