Buy-Side Diligence on a $12M IT Services Acquisition

The situation

A mid-sized IT services firm was acquiring a smaller competitor for $12M and needed to confirm the target's financial health before wiring the money.

That is the whole job of buy-side diligence, and it is easy to underestimate on a deal this size. A $12M acquisition is large enough that a material misstatement changes the economics entirely, but small enough that buyers often rely on the seller's own presentation and a conversation with their accountant.

The asymmetry is the problem. The seller has lived with these numbers for years and knows exactly which ones are soft. The buyer has a data room, a deadline, and a management team that is also trying to run its own business.

What we did

Conducted a detailed financial review of the target. Detailed means working from source documents rather than from the summary the seller prepared. A presentation is an argument; the underlying records are evidence, and the two do not always agree.

Analyzed cash flow and working capital for post-acquisition funding needs. What a business earns and what it needs to keep operating are different questions. A target can be profitable and still require the buyer to inject cash in the first quarter after close, and that requirement should be priced in rather than discovered.

Helped structure an earn-out to align buyer and seller incentives. Where a valuation depends on performance that has not happened yet, an earn-out moves that risk to the party best placed to influence it. It is a mechanism for proceeding on a disagreement about the future rather than abandoning the deal over it.

What changed

The review uncovered $500K of overstated revenue, and an earn-out was structured to protect the buyer.

Deal terms were renegotiated on accurate data rather than on the seller's presentation. Financial integration went smoothly post-close, and the buyer's investment was protected.

Two of those outcomes are worth separating. Finding the overstatement changed the price. Structuring the earn-out changed the risk — and it is the second that usually matters more, because it governs what happens if the future does not go the way either side expected.

What this means for acquirers

The cost of diligence is almost always small relative to what it protects, and the argument against it is almost always time.

That trade looks different once you have seen a number move. On a $12M deal, a $500K revenue overstatement is roughly 4% of the purchase price found by reading the source documents rather than the summary — before any consideration of what it implies about the rest of the reporting.

The questions worth asking on any acquisition of this size: does the revenue reconcile to cash actually received, what will the business need funded in the first quarter after close, and which parts of the valuation depend on performance that has not happened yet.

The last of those is not usually solved by a lower price. It is solved by structuring the deal so both sides carry the risk they can actually control.