Due Diligence 101: Financial, Legal & Operational Checks for M&A

Mergers and Acquisitions (M&A) are among the most significant decisions a business can make. Whether it’s a growing company acquiring a competitor, an investor funding a startup, or a large corporate restructuring its portfolio, one principle remains the same: no deal should be made without thorough due diligence.

Due diligence is essentially the deep investigation of a company’s financial, legal, operational, and commercial aspects before finalizing a transaction. It answers critical questions:

• Is the target company worth the price?

• Are there hidden liabilities or compliance risks?

• Will the deal deliver long-term value?

In this guide, we’ll explore what due diligence means, its types, its role in M&A transactions, key checklists, and best practices for businesses in India and globally.

What is Due Diligence?

At its core, due diligence is the process of fact-checking a business before signing a merger, acquisition, partnership, or investment agreement. It involves collecting, verifying, and analyzing information to uncover risks, liabilities, and growth opportunities.

Think of it as a business equivalent of a medical check-up. Just as a doctor runs tests before a surgery, companies must run due diligence before a transaction to avoid unpleasant surprises.

Why is Due Diligence Important in M&A?

M&A deals are complex, involving millions (sometimes billions) in investment. Without due diligence, companies risk:

• Overpaying for the deal

• Inheriting lawsuits, debts, or tax problems

• Facing cultural or operational integration issues

• Regulatory penalties due to non-compliance

Key Benefits of Due Diligence:

1. Accurate Valuation – Determines the real worth of a company.

2. Risk Mitigation – Identifies hidden liabilities and compliance gaps.

3. Informed Decision-Making – Helps buyers decide whether to proceed, renegotiate, or walk away.

4. Regulatory Compliance – Ensures deals align with laws in India and globally.

5. Integration Planning – Provides insights into HR, IT, and cultural aspects for smoother post-merger integration.

Types of Due Diligence in M&A

Due diligence isn’t one-size-fits-all. Depending on the nature of the deal, different aspects of the company are investigated.

1. Financial Due Diligence (FDD)

• Examines historical financial statements, revenue streams, debt, tax liabilities, and working capital.

• Answers: Is the company financially stable? Are profits sustainable? Are assets correctly valued?

2. Legal Due Diligence (LDD)

• Reviews corporate structure, contracts, intellectual property rights, litigation history, licenses, and compliance.

• Answers: Are there any lawsuits? Are contracts enforceable? Is IP properly protected?

3. Operational Due Diligence (ODD)

• Focuses on internal processes like HR, supply chain, IT systems, and customer relations.

• Answers: Is the company operationally efficient? Can it scale post-merger?

4. Commercial Due Diligence (CDD)

• Evaluates market position, competition, customer base, and growth opportunities.

• Answers: Does the company have a strong market presence? What is its long-term potential?

5. Environmental, Social & Governance (ESG) Due Diligence

• Increasingly relevant in India and worldwide. Reviews sustainability, labor practices, and ethical compliance.

Due Diligence Checklist for M&A in India

Here’s a comprehensive checklist that investors, buyers, and financial institutions typically follow:

🔹 Financial Due Diligence

• 3–5 years of audited financial statements

• Revenue breakdown by product, customer, region

• Debt obligations and credit facilities

• Tax filings, GST, TDS, and transfer pricing records

• Working capital assessment

🔹 Legal Due Diligence

• Certificate of incorporation, MoA, AoA

• Shareholding pattern and ownership structure

• Material contracts, vendor and customer agreements

• IP ownership (patents, trademarks, copyrights)

• Pending or potential litigations

• Regulatory approvals (RBI, SEBI, FEMA for cross-border deals)

🔹 Operational Due Diligence

• HR policies, payroll structure, attrition rates

• IT systems, cybersecurity, software licenses

• Supply chain contracts and vendor dependencies

• Customer complaint records

• Insurance policies

🔹 Commercial & Strategic Due Diligence

• Competitor analysis

• Market growth forecasts

• SWOT analysis (Strengths, Weaknesses, Opportunities, Threats)

• Industry-specific risks

Due Diligence in the Indian Context

In India, M&A due diligence has some unique aspects compared to global markets:

1. Regulatory Compliance – Companies must comply with laws such as:

   • Companies Act, 2013

   • SEBI regulations (for listed companies)

   • FEMA (for cross-border M&A)

   • Income Tax Act & GST provisions

2. Cultural Integration – Especially relevant when foreign firms acquire Indian companies, as organizational culture and work practices may differ.

3. Litigation Risks – Indian companies often have pending disputes, so legal due diligence is crucial.

4. Infrastructure & Operational Risks – Supply chain inefficiencies, regulatory delays, or sector-specific hurdles (e.g., in real estate or telecom).

Steps in a Due Diligence Process

A typical M&A due diligence process follows structured steps:

1. Preparation – Define scope, set timelines, sign NDAs.

2. Document Collection – Request financial, legal, operational, and market data.

3. Analysis & Verification – Review information, cross-check with independent sources.

4. Interviews & Site Visits – Meet key stakeholders, inspect facilities.

5. Risk Assessment – Highlight potential red flags and liabilities.

6. Report Preparation – Summarize findings in a Due Diligence Report (DDR).

7. Decision-Making – Buyer decides to proceed, renegotiate, or withdraw.

Common Red Flags Identified During Due Diligence

• Unreported tax liabilities

• Inflated revenues or underreported expenses

• Weak internal controls or lack of ERP systems

• Legal disputes not disclosed initially

• Over-dependence on a single customer or vendor

• Environmental violations or non-compliance fines

• Employee unrest or high attrition rates

Spotting these early helps prevent costly mistakes.

Future of Due Diligence in India

As India’s M&A market matures, due diligence is becoming more data-driven and technology-enabled. Some future trends include:

• AI & Analytics – Automating financial analysis, fraud detection, and risk assessment.

• Virtual Data Rooms (VDRs) – Secure cloud platforms for document sharing.

• ESG-Focused Reviews – Sustainability and ethical factors gaining weight in investment decisions.

• Cross-Border M&A Growth – More Indian companies entering global partnerships.

Best Practices for Effective Due Diligence

• Start early – Don’t wait until deal closing.

• Engage multidisciplinary experts – finance, law, tax, and operations.

• Use digital tools for faster, accurate reviews.

• Keep communication open with the target company.

• Always validate data with third-party sources.

Conclusion

Due diligence is the backbone of successful M&A transactions. It ensures buyers, investors, and financial institutions make informed decisions based on facts, not assumptions.

A structured due diligence process covering financial, legal, operational, and commercial checks not only mitigates risks but also uncovers opportunities for growth and synergy. As businesses increasingly rely on expert insights, demand for professional due diligence services in India continues to rise.

In the Indian context, where regulatory complexity and litigation risks are high, comprehensive due diligence is non-negotiable for any merger or acquisition.

Whether you’re a corporate investor, startup founder, or financial institution, remember: the quality of due diligence can make or break your deal.

Frequently Asked Questions (FAQs)

Q1. What is the main purpose of due diligence in M&A?

Ans: To verify the financial, legal, and operational health of a company and reduce risks before finalizing a transaction.

Q2. How long does due diligence take in India?

Ans: Typically 4–12 weeks, depending on the size and complexity of the deal.

Q3. Who performs due diligence?

Ans: Specialized consultants, financial advisors, auditors, and legal experts.

Q4. What are the biggest risks if due diligence is skipped?

Ans: Hidden debts, lawsuits, tax penalties, overvaluation, and operational inefficiencies.

Q5. Is ESG due diligence mandatory in India?

Ans: Not mandatory yet, but increasingly important for investors and multinational buyers.

Q6. What documents are required for financial due diligence?

Ans: Audited financials, tax filings, debt schedules, revenue reports, and working capital analysis.

Q7. Can due diligence affect valuation?

Ans: Yes, findings often lead to renegotiation of deal terms or price.

Q8. What is a Virtual Data Room (VDR) in due diligence?

Ans: A secure online platform used for sharing and reviewing confidential deal documents.

Q9. How does cultural due diligence matter in M&A?

Ans: It helps assess HR practices, management style, and employee adaptability for smoother integration.

Q10. Is due diligence the same for startups and large companies?

Ans: No, startups focus more on growth potential and IP, while large firms require deeper financial and compliance checks.