Due diligence: what gets checked in a company and where the check runs up against disclosure

Due diligence is a procedure for examining a target before a deal, and its purpose is not to "find out more" but to turn the seller's claims into verifiable facts and put a price on every discrepancy. The buyer of a business arrives with a set of statements they have been told: revenue is this much, debt is that much, the licences are in order, the lawsuits are trivial. The review works through those statements in turn and demands a document for each — a contract, an acceptance certificate, a bank statement, a court ruling, an auditor's report — and records what was confirmed, what was not confirmed and what was confirmed only in part. The outcome is not a "good company" or a "bad company" but a list of identified risks, each marked according to whether it is covered by the price, covered by warranties and representations in the agreement, or cannot be covered at all and means walking away from the deal.

Why it matters in corporate finance

A sale of a business is structured so that the seller knows almost everything about the target and the buyer knows almost nothing. Due diligence exists to narrow that gap to a manageable size, and its findings have direct financial consequences. An outstanding guarantee issued for a subsidiary, a hidden pledge of shares, an expired licence, an additional tax assessment looming within the period under review — every such finding is either deducted from the price or carried into a separate seller's representation backed by an indemnity. That is why, in M&A, the report of the due diligence team is read not only by the investment committee but also by the lawyers, who build the contractual protection out of it: representations and warranties, deferred payments, escrow, exit terms.

Areas of review

The legal workstream answers the question of whether the seller actually owns what is being sold: the chain of title to participatory interests and shares, corporate approvals, encumbrances, restrictions in the charter, minority shareholders' rights, court and administrative proceedings, and the status of rights to real estate and intellectual property.

The financial workstream reconciles the financial statements with the source documents and looks for gaps between profit and cash: revenue recognition, concentration on large counterparties, the quality of receivables, off-balance-sheet liabilities, related-party transactions, and the structure and covenants of the debt, including cross-default provisions.

The tax workstream assesses the positions on which the tax authority may take a different view and calculates the potential additional assessments for periods that are still open. The operational and technical workstream verifies that the production assets physically exist, are maintained and do not require immediate investment. The HR and compliance workstream looks at key employment contracts, dependence on particular individuals, and anti-corruption and sanctions risks.

How a minority investor's check differs from that of a buyer of a business

This is a fundamental point, and it gets lost when the words "due diligence" are carried over to buying shares on the exchange. The buyer of a controlling stake gets access to a data room: internal contracts, detailed breakdowns, management accounts, interviews with management. A retail investor has no such access and never will. All that is available to them is what the company has disclosed publicly — and in substance their check is closer to an analysis of disclosure than to classic due diligence.

What can actually be checked from the outside

The financial statements and the auditor's report — above all the auditor's opinion itself: a modified opinion, a qualification or a paragraph on material uncertainty related to going concern matters more than any line on the balance sheet. Next come the notes to the financial statements, which is where related parties, pledges, legal claims and the maturity structure of the debt are to be found. Published filings and disclosure deadlines are easy to track in the issuer reports section.

Corporate actions and material facts: a change of auditor, the departure of the chief financial officer, a pledge of the main owner's shares, an additional share issue, a reorganisation. Issuers' announcements and the market context are in the news feed, and scheduled events are in the events calendar.

Payment discipline as an indirect test of honesty: whether the declared payouts match the dividend policy, and whether decisions are actually carried out. The nearest declared payouts are

And the history and parameters are in the dividends section. For debt instruments there is a separate check — the issue documentation and the covenants: the issues themselves are listed in the bonds and OFZ sections, and the structure of the security there matters more than the yield. Comparable securities from the same sector, for checking whether "it is like this for everyone", are in the stocks section.

Red flags that are visible from the outside

A divergence between profit and operating cash flow that drags on from period to period. Revenue growth accompanied by even faster growth in receivables. A change of auditor following an inconvenient opinion. Regular large related-party transactions with no clear economic rationale. Postponed disclosure and a reduction in its scope. Debt for which most of the repayments fall on one near-term date. None of these signs is a verdict in itself — but each of them requires an explanation, and the absence of an explanation is information in its own right.

What due diligence is not

It is neither a forecast nor a valuation. The review establishes the condition of the target as of a given date and the quality of the information about it; how much the target is worth and what will happen to it next is separate work, which uses the findings of the review as an input. Hence a common mistake: a thorough review is taken as a guarantee of the outcome. It reduces the likelihood of an unpleasant surprise arising from what has already happened, but it is not responsible for the future.

A related logic applies in quantitative analysis as well: a model fitted to known data proves nothing until it has been tested on data it has not seen — see out-of-sample testing and the glossary of terms.

What is not covered here

This article describes the logic and the areas of a review, not the procedural requirements of any particular deal. The set of documents, the length of the period under review, the form of the report and the allocation of liability between the parties are determined by the sector, the size of the deal and the arrangements between the participants — that data is not available here, and substituting a standard checklist for it would be fabrication. For a deal involving a real target, this part is put together by the legal and financial advisers to suit the specific structure.