Financial Due Diligence
Financial due diligence is the buyer's investigation of a target's financial position and performance before it commits: the quality of its earnings, the reliability of its accounts, its working capital and cash conversion, its net debt and off-balance-sheet obligations, and the credibility of its forecasts. It produces the numbers the price, the adjustments and the warranties are built on, and in a fintech it extends into the regulatory balance sheet the accounts do not show.
- Also known as
- FDD, Financial DD, Accounting due diligence
- Used at
- confirmatory diligence after heads of terms; in an auction, the second round; sometimes as vendor due diligence commissioned by the seller and relied on by all bidders
- Binding
- no — a report to the buyer (with a reliance letter if the lenders or insurers also rely on it); its findings become binding through the price, the completion mechanism and the warranties
- Typical scope
- three years of historical accounts and the current year to date; revenue and margin by product, customer and cohort; EBITDA and its adjustments; working capital by month; net debt and debt-like items; capex; tax; forecasts and the assumptions behind them
- Typical cost and time
- 0.3–1% of the deal value and four to eight weeks, run by an accounting firm's transaction team
- Parties
- the buyer, its accountants and its lenders; the target's finance team, which answers the questions; the seller's advisers, who manage the flow
How financial due diligence works in practice
The team starts from the accounts and works towards the cash. Reported revenue is broken down — by product, customer, geography, cohort — and reconciled to contracts and bank receipts; the recurring is separated from the one-off. EBITDA is normalised: management's add-backs are tested, the team's own adjustments are added, and the run-rate is set. Working capital is rebuilt month by month to see the seasonality and to set the target the price will be adjusted against. Net debt is listed with every debt-like item: accrued bonuses, deferred revenue, unpaid tax, deferred consideration, lease liabilities, customer credits. The forecast is tested against the history and against what the team has seen in the market.
For a fintech, three further questions. Where is the client money, is it safeguarded correctly, and does it reconcile daily — a safeguarding shortfall is both a debt-like item and a regulatory breach. What regulatory capital does the licence require now and at the volumes in the forecast, and is it held. And what does the take rate look like by merchant or product over time, because a payments business whose revenue grows while its take rate falls is being priced on a margin that is leaving.
The report is not an audit. It does not verify every balance; it tells the buyer what the business earns, what it owes, what it needs, and where the seller's numbers and the buyer's price disagree.
Example
A buyer commissions financial due diligence on an e-money institution with €18m of revenue and €4.5m of adjusted EBITDA. The team finds: normalised EBITDA of €3.9m after rejecting €0.6m of add-backs; a take rate that fell from 1.4% to 1.1% over two years while volume grew 60%; working capital that swings €2m across the year, with the seller's proposed target at the low point; a safeguarding reconciliation with a €300,000 unexplained difference in two of the last twelve months; and own funds €400,000 below what the forecast volume would require in eighteen months. The buyer reprices from €40m to €35m, sets the working capital target at the twelve-month average, takes a specific indemnity for the safeguarding difference, and plans a €1m capital injection at completion. The seller, faced with a report it cannot rebut, accepts €36m.
Common mistakes
- Running financial diligence after the price is fixed, so every finding is a fight rather than an input. - Accepting the seller's monthly management accounts without reconciling them to the audited ones and to cash. - A scope that stops at EBITDA and never rebuilds working capital, where the last million is. - For a fintech, reading the statutory accounts and never the safeguarding reconciliations or the capital return. - Treating vendor due diligence as the buyer's own; it was written for the seller.