Due Diligence · 8 min read
Red Flags Found in Company Due Diligence (and What They Cost)
Almost every transaction produces findings. What separates a good deal from a bad one is whether those findings are discovered before signing and correctly translated into price, structure or protection.
Financial red flags
Findings that change the numbers
Revenue that will not reconcile
Reported sales that do not tie to bank receipts and tax filings are discounted heavily. Unreconciled revenue is treated as unproven until evidence appears.
Unrecorded liabilities
Unbooked supplier dues, employee arrears, undisclosed guarantees and pending tax demands reduce equity value rupee for rupee at closing.
Ageing receivables
Long-outstanding debtors carried at full value inflate both profit and working capital. Provisioning them often removes a full year of reported growth.
One-off income treated as recurring
Asset sales, subsidies, forex gains and exceptional contracts inflate EBITDA. Removing them lowers the base to which the multiple is applied.
Deferred maintenance capex
Under-investment flatters current profit and creates a spend the buyer inherits. It is usually deducted from price or funded through a holdback.
Working capital drift
A target delivered with a depleted operating base forces the buyer to inject cash immediately, which is a price adjustment in all but name.
Structural red flags
Findings that change the risk
- One customer contributing a large share of revenue, with no long-term contract.
- Material revenue from related parties or entities controlled by the promoter.
- Key contracts that terminate or need consent on change of control.
- Licences, permits or registrations that are lapsed, pending or non-transferable.
- Statutory arrears in GST, TDS, PF or ESI, with interest and penalty exposure.
- Intellectual property, domains or code registered personally rather than to the company.
- Undocumented employment terms, informal payroll or unrecorded incentive promises.
- Litigation or regulatory notices disclosed late in the process.
Late disclosure is itself a finding
Impact
How findings translate into price and protection
A finding is not automatically a deal-breaker. It becomes a negotiation about who carries the risk and at what cost.
- Quantifiable liabilities become a direct reduction in the equity price.
- Contingent exposures are covered by escrow, holdback or a specific indemnity.
- Repeatability concerns move consideration into an earn-out linked to performance.
- Concentration and owner dependence compress the multiple rather than the earnings.
- Unresolved statutory or ownership defects become conditions precedent to closing.
- Findings that cannot be sized or bounded are a legitimate reason to walk away.
For sellers
Fix these before you go to market
Sellers lose more value to preventable findings than to hard negotiation. Most of the items below can be corrected in a few months of preparation.
- Reconcile revenue to bank and tax records for the last three years.
- Clear statutory arrears and close open notices before diligence begins.
- Formalise contracts with major customers and suppliers.
- Transfer personally held IP, domains and licences into the company.
- Document processes so the business is not dependent on one person.
- Commission a valuation early so your asking range is evidence-based.
FAQ
Questions about diligence findings
What is the most common red flag in company due diligence?+
Customer concentration. A single client contributing a large share of revenue is both the most frequent finding and the one most likely to reduce the multiple, because the earnings it supports may not survive the transfer.
Do findings always reduce the price?+
No. Many are resolved through structure rather than price, such as escrow, indemnities, conditions precedent or an earn-out that pays the seller only if performance continues.
Should an investor buying a minority stake run diligence?+
Yes. A minority investor has less control and fewer exit routes, so unrecorded liabilities and governance defects are relatively more damaging, not less.
Can diligence findings be raised after signing?+
Only where the agreement allows it, through warranty claims or indemnities. That is far harder than repricing before signature, which is why the sequence matters.
Find the issues while you still have leverage.
Share the target and the stage you are at, and we will scope diligence around the risks that matter.