What Happens During Due Diligence, Step by Step

Most sellers go into due diligence with a vague sense that it involves handing over paperwork.

It involves handing over most of the paperwork your business has generated in three years, to people whose job is to find what’s wrong with it, while you keep the business running and keep the process confidential from your team.

Knowing the sequence ahead of time doesn’t make it easier. It makes it predictable, which is close enough to be useful.

Before the letter of intent

Diligence starts before anyone calls it that.

A buyer researching your business looks at your website, your reviews, your online presence, and whatever public records exist. If they’re serious they’ll want conversations with you, a look at high-level financials, and a sense of how the business runs.

At this stage you’re under no obligation to hand over detail. A summary of revenue, owner earnings, and customer mix is normal. Full tax returns are not, until there’s an NDA and a reason.

Buyers who push for complete financials before an NDA are either inexperienced or testing how you handle boundaries. Either way, the answer is the same.

The letter of intent

The LOI sets the price, the structure, and the timeline. It’s mostly non-binding on the deal terms, with two exceptions that bind you.

The first is confidentiality. The second is exclusivity, sometimes called a no-shop clause, and it’s the one that changes your position.

Exclusivity means you stop talking to other buyers for a defined window. Thirty days, sixty, ninety, sometimes longer. During that period this buyer is your only buyer, and both of you know it.

That’s the point where your leverage starts declining, and it declines further every week the process continues. Negotiate the exclusivity window before you sign it. A shorter window with an option to extend is better for you than a long one.

Read the LOI with an attorney who has done these deals. Not your general business attorney. Someone who works on transactions.

The document request

Within days of signing, you’ll get a request list. For a small business deal, expect something between forty and a hundred and fifty items.

It covers:

• Financials. Three years of tax returns, profit and loss statements, and balance sheets. Bank statements. Accounts receivable and payable aging. A detailed general ledger. Your add-back schedule with support for each item.
• Contracts. Every significant customer contract. Vendor agreements. Your lease. Equipment leases and loan documents. Insurance policies. Licenses and permits.
• People. Employee census with compensation, employment agreements, non-competes, benefit plans, and workers comp history.
• Operations. Your org chart, process documentation, customer list with revenue by account, and anything describing how the business runs.
• Legal. Litigation history, tax notices, environmental matters if relevant, and a list of anything with the potential to become a claim.

The list arrives all at once and looks impossible. It’s assembled from a template, and some items won’t apply to you. Say so rather than leaving gaps unexplained.

How the buyer works through it

Financial diligence runs first and deepest.

The buyer’s accountant reconstructs what your business earns. They start with your tax returns, because those are the version you signed under penalty of perjury, and they work toward your adjusted number by examining each add-back.

Every personal expense that ran through the business becomes a line item someone asks about. The vehicle. The phone. The travel. The family member on payroll. Each one needs an explanation and support.

If the purchase price is $3 million or more and SBA financing is involved, the new SBA rules require a Quality of Earnings report ordered by the lender. That’s a third party reconstructing your earnings in detail, and their number is the one the lender uses.

Operational diligence follows. A site visit, conversations about how work gets done, a look at your systems and processes. The buyer is checking whether the business you described matches the business they observe.

Legal diligence runs in parallel. The buyer’s attorney reads every contract and flags what doesn’t transfer, what has a change-of-control provision, and what’s missing entirely. Verbal agreements with major customers show up here as a problem.

Customer and employee conversations come last, if they happen at all, and they’re controlled. No serious buyer calls your customers early. That would breach confidentiality and put the deal at risk for both of you.

The lender’s separate process

If your buyer is using SBA financing, and most buyers in the $1M to $5M range are, there’s a second diligence running alongside the first.

The lender underwrites independently. They review the same financials with different criteria, order an independent business valuation, and after October 1 they have to analyze whether that valuation supports the purchase price.

This surprises sellers. You can satisfy your buyer completely and still have the deal stall because the lender’s analysis came back differently.

It also adds time. Lender diligence runs on its own schedule, and a file waiting on underwriting sits still no matter how responsive you’ve been.

What findings do

Everything the buyer discovers lands in one of three places.

Items that confirm what you represented get noted and set aside. Items that are small and explainable get discussed and usually accepted.

Items that are material, meaning they change what the business is worth or what the buyer is taking on, become the basis for renegotiation. A price reduction. A larger escrow holdback. An earnout replacing cash at closing. A transition requirement that keeps you working longer.

This is where preparation pays or costs. A seller who fixed the problems before going to market has few findings in that third category. A seller who didn’t has a list, and each item is leverage the buyer didn’t have to manufacture.

There’s a version of this that’s less honest, where a buyer uses minor findings as pretext to reduce a price they always intended to reduce. It’s called retrading, and it works because you’ve been off the market for months by then.

Both versions look the same from the inside. The defense against both is the same too.

Purchase agreement to closing

Once diligence concludes, attorneys draft the definitive purchase agreement. This is the binding document, and it’s where the deal gets made.

Reps and warranties, indemnification, escrow terms, working capital adjustments, the non-compete, the transition agreement. Terms that felt settled in the LOI get negotiated again in specific language.

Then closing conditions: lender approval, landlord consent if your lease requires it, third-party consents on contracts that need them, and whatever else the agreement lists.

The gap between “diligence is done” and “money is wired” runs weeks, sometimes longer.

What surprises sellers most

The volume. The document requests keep coming. Answering one generates three follow-ups. This continues for the full window.

That you’re running the business the whole time. Diligence is a second job layered on your first one, and it arrives without warning about which weeks will be heavy. Sellers who are already the operational center of their business feel this hardest, and the business often shows the strain.

The long quiet stretches. You’ll go two or three weeks with no contact. Buyers work in bursts, and most of that time they’re waiting on their lender or their accountant. Sellers read the silence as a signal and start calling. There’s usually nothing behind it.

The emotional weight. Every question about your business reads as a criticism of something you built. Most of them aren’t. Knowing that in advance helps a little.

How much it costs. Your attorney bills hours through this. A sell-side quality of earnings analysis costs money. So does whatever your CPA does to support the add-back schedule. These are real expenses incurred before you know whether the deal closes.

What you can do about it now

The sellers who come through diligence intact do three things ahead of time.

They assemble the documents before anyone asks. Three years of financials, contracts, employee records, licenses, and the add-back schedule with support. Having it ready turns a scramble into a transfer.

They find their own problems first. Whatever a buyer would flag, they flagged, and either fixed it or prepared to disclose it. A problem you disclose is a negotiating point. A problem a buyer discovers is a trust event, and the second one is more expensive.

They build capacity to absorb the process. A business that runs without the owner can survive an owner who spends two months answering document requests. A business that can’t, can’t.

None of that happens in the thirty days between an LOI and the first request list. It happens in the twelve to thirty-six months before a buyer shows up.