Why Diligence Failures Are So Common

Financial due diligence is often treated as a confirmatory exercise — the deal is mentally done, and the diligence is just a box to check. This is a dangerous mindset. The most costly acquisition mistakes we've seen came not from bad deals, but from diligence processes that were too narrow, too rushed, or too deferential to the seller's narrative.

After advising on dozens of buy-side and sell-side mandates across India, we've seen the same warning signs repeatedly. Here are the five that matter most.

Red Flag 1: Revenue Concentration Risk

A business that derives more than 30–40% of its revenue from a single customer or a handful of related entities is fundamentally more fragile than its headline numbers suggest. This is the single most common issue we find in SME and mid-market acquisitions.

The problem is rarely disclosed upfront. Sellers present a diversified revenue story at the information memorandum stage. The concentration only becomes apparent when you analyse the customer-level revenue data — which is why requesting aged debtor schedules and customer-wise revenue breakdowns early in diligence is non-negotiable.

What to look for:

  • Top 5 customer concentration as a percentage of total revenue for each of the last 3 years
  • Customer retention rates and contract tenure
  • Whether any top customers are related parties to the promoter
  • Pending contract renewals or customer negotiations at the time of sale

If a single customer accounts for more than 25% of revenue, the valuation multiple should reflect this risk explicitly — either through a lower base multiple or an earn-out structure tied to customer retention.

Red Flag 2: Normalised EBITDA That Isn't

Every seller's financial presentation includes "normalised" or "adjusted" EBITDA — earnings adjusted for one-off items, related-party transactions, and founder perquisites. The problem is that these adjustments are sometimes aggressive, sometimes duplicated, and occasionally fictitious.

Common adjustments we scrutinise:

  • Founder salary add-backs: Legitimate if the role will be replaced by professional management at a lower cost. Not legitimate if the founder is staying and the add-back has no economic basis.
  • Related-party rent and services: If the company rents premises from a promoter-controlled entity at below-market rates, the "savings" can't simply be added back — they disappear post-acquisition when market-rate leases are signed.
  • One-off legal or restructuring costs: These become suspect when the same "one-off" appears in two or three consecutive years.
  • Revenue accruals: Check whether revenue has been pulled forward from future periods to inflate the trailing twelve months (TTM) used for valuation.

Red Flag 3: Undisclosed Contingent Liabilities

Contingent liabilities — tax demands, litigation, regulatory penalties, warranty claims — are one of the most common sources of post-acquisition disputes. They often don't appear on the balance sheet and are buried in notes to accounts or not disclosed at all.

Areas to probe specifically in Indian acquisitions:

  • GST and service tax demands: Particularly common in sectors that transitioned through the GST regime with unresolved legacy positions.
  • Income tax assessments: Ask for details of all years under assessment, pending appeals, and any tax positions taken that diverge from common practice.
  • Labour and PF/ESI disputes: Especially in manufacturing or labour-intensive businesses. Often undisclosed because the promoter doesn't view them as "real" liabilities.
  • Customer and vendor litigation: Review all pending cases filed by and against the company, not just the large ones.

Always ask for a legal due diligence report from independent counsel as a non-negotiable part of the buy-side process. Representations and warranties in the SPA are useful but are meaningless if the seller doesn't have the financial capacity to honour indemnity claims post-closing.

Red Flag 4: Working Capital Manipulation

Working capital — the difference between current assets and current liabilities — is typically a key closing adjustment in acquisition agreements. Sellers have every incentive to inflate working capital at the measurement date, and there are multiple ways to do so that are not immediately obvious.

Common manipulation techniques:

  • Deferred creditor payments: Pushing trade payables past the measurement date to reduce current liabilities and inflate net working capital.
  • Inflated inventory: Overstating inventory values, particularly where inventory is physically difficult to verify (bulk commodities, WIP in manufacturing).
  • Stale receivables kept on books: Old, uncollectable receivables that should have been written off but remain to inflate current assets.

The defence: agree on the working capital peg and definition before signing — and ensure your SPA provides for an independent expert determination of the closing adjustment if the parties disagree.

Red Flag 5: Key Person Dependency

This risk is underweighted in financial diligence but often determines whether an acquisition creates or destroys value. In Indian SMEs especially, businesses are frequently built around the founder's relationships, domain expertise, or operational involvement in a way that makes the business fundamentally less valuable without them.

Questions to ask:

  • What percentage of customer relationships are personal to the promoter?
  • Are key supplier agreements or credit limits tied to the promoter's personal guarantee?
  • Is the team capable of operating independently? What is the second-tier management quality?
  • What is the planned transition arrangement — and is it realistically adequate?

The mitigant is usually a structured post-closing transition period, an earn-out tied to business performance, and retention agreements for the next tier of management. But none of these work if the dependency is not identified in diligence first.

The Bottom Line

Good due diligence is not about finding reasons not to do a deal. It's about understanding what you're actually buying — and pricing the risks appropriately. Deals with red flags can still be excellent acquisitions if the risks are identified, quantified, and reflected in the price and structure.

The deals that destroy value are the ones where these issues surface after closing, when the leverage has shifted entirely to the seller and the acquirer is left managing consequences they didn't price.

This article is for informational purposes only and does not constitute legal, tax, or financial advice. Please consult with a qualified professional for advice specific to your situation. Maroon Advisors would be delighted to assist — get in touch.