Due diligence is not a checklist: what buyers and investors should really be testing

In a transaction, the most expensive mistakes are often made before the deal is signed.

Buyers and investors rarely lose money because they failed to receive a checklist. They lose money because the checklist did not ask the right questions, or because excitement, urgency and exclusivity caused the right questions to be ignored.

When an opportunity is presented as limited, exclusive or time-sensitive, the discipline of due diligence becomes even more important. A strong advisory process should slow the decision down long enough to test the fundamentals: the quality of the earnings, the reliability of cash flows, the strength of the balance sheet, the tax position, the commitments that sit outside the obvious numbers, and the governance risks that may only become visible after the transaction.

Due diligence should test the story behind the numbers

A financial model or investor presentation may show attractive growth, strong margins and an exciting market opportunity. But due diligence should ask whether the story is supported by evidence.

The key question is not only whether the business made a profit. The better question is whether the profit is sustainable, cash-generating and repeatable under normal trading conditions.

What buyers and investors should really be testing

1. Quality of earnings

Reported profit does not always equal maintainable earnings. Due diligence should identify once-off income, unusual expenses, owner-managed adjustments, aggressive revenue recognition, margin pressure and any normalisation adjustments needed to understand the true earnings base.

2. Working capital and cash conversion

A profitable business can still place pressure on cash. Buyers should understand debtor recoverability, inventory quality, supplier payment patterns, working capital seasonality and whether the business requires more cash than the headline numbers suggest.

3. Liquidity and exit assumptions

If an investment opportunity depends on future buyers, future refinancing or a future market exit, the liquidity assumptions must be tested. A simple but important question is: where does the cash come from, and who carries the risk if the exit does not happen as planned?

4. Tax and compliance exposures

Tax risks can transfer value away from the buyer after the transaction. Due diligence should consider income tax, VAT, PAYE, provisional tax, historical disputes, uncertain tax positions and whether the business has complied with its statutory obligations.

5. Related-party transactions

Related-party transactions can distort the true performance of a business. Buyers should understand loans, management charges, shared costs, guarantees, supply arrangements, owner benefits and whether the business can operate independently after the transaction.

6. Contingent liabilities and commitments

Not every liability is visible on the face of the balance sheet. Due diligence should identify guarantees, litigation, lease commitments, regulatory exposures, supplier disputes, customer claims, warranty obligations and contractual penalties.

7. Revenue concentration and customer risk

A business may appear stable until the buyer understands that revenue depends on a small number of customers, contracts or relationships. Due diligence should assess customer concentration, contract terms, renewal risk, pricing pressure and dependency on key individuals.

8. Governance and control environment

The quality of the finance function, internal controls, reporting discipline and governance culture matters. Weak reporting, poor reconciliations, unclear approval processes and incomplete records are not only administrative issues; they can affect value, accountability and post-acquisition integration.

Exclusivity should not replace evidence

One of the most common transaction risks is the psychology of the deal. Words such as “exclusive”, “limited allocation”, “urgent opportunity” or “high demand” can create pressure to act quickly. That is exactly when buyers and investors should become more disciplined, not less.

Good due diligence does not kill good deals. It protects good deals by identifying the risks early, quantifying them properly and giving the parties a better basis for negotiation, warranties, price adjustments and post-transaction planning.

How HLB CMA South Africa Inc. can assist

HLB CMA South Africa Inc. provides advisory support for mergers and acquisitions, due diligence engagements, financial analysis, performance management and business improvement. Our work is designed to help buyers, sellers, shareholders and investors understand the risks, test the assumptions and make better-informed decisions.

Whether the transaction involves a private company, owner-managed business, investment opportunity, public sector project, not-for-profit entity or development programme, the principle remains the same: the decision should be supported by evidence, not excitement.

With ownership comes responsibility. Proper due diligence is one of the ways that responsibility is exercised before value is placed at risk.