Seeing around corners: why a two-phase due diligence approach protects value

In the mid-market, deals often hinge on imperfect information. Everyone is trying to make investment decisions with limited information. What frequently gets overlooked is that significant value shifts can happen before the term sheet is signed-often quietly and with little room to reverse.

Just as working capital seasonality can move your purchase price without you noticing, early assumptions about revenue quality, margins, quality of earnings, and cash conversion can affect valuations – and before you know it, the gap is wide. 

Post-term sheet discovery

Traditionally, buyers commit commercially and only begin detailed financial due diligence after the term sheet. But by then, your range is set, and your negotiating latitude narrows. Findings that emerge at this stage, such as normalisation gaps, margin volatility, customer churn or cash requirements, may necessitate renegotiation. Late-stage surprises introduce tension, slow down momentum, and can derail a deal altogether.

A different approach is needed—one that manages financial, operational, and even psychological deal risks earlier. 

Introducing two-phase financial due diligence

 Phase one: Red flag due diligence (often pre-term sheet) – clarity before you commit

This first phase is designed to help you make a well-informed offer with discipline and confidence. It is not a full deep dive, but rather a focused review of the factors that influence valuation and structure, based on selected information or a vendor due diligence report.

It identifies:

• Core revenue drivers and early views on sustainability or concentration risks.
• Indicative normalised EBITDA.
• High level view on cash burn and working capital funding requirements.
• Early red flags that may impact price or structure.
• Implications for term sheet design such as ranges, conditions, earn-out logic or completion mechanisms.

This mirrors the early-stage clarity needed to avoid traps such as mis-set working capital pegs, underestimated funding requirements and misaligned revenue or earnings expectations-all of which can move value significantly even when both sides negotiate in good faith.

The outcome is a short, practical memo with specific analysis that gives you a grounded view of value before you put forward your initial offer. 

Phase two: post-term sheet deep dive – confirm, validate, refine

Once a term sheet is executed, phase two builds on the foundations laid earlier.
This phase includes:
 

• Full quality-of-earnings analysis.
• Detailed revenue analytics and margin profiling.
• Trend analysis.
• Working capital assessment.
• Debt-like items identification.
• Accounting policy review.
• Commentary on the purchase agreement and value bridge.

Because phase one already clarifies the key questions, the confirmatory phase is more focused, more efficient and typically faster.

A better way forward

Transactions are not solely financial; in the mid-market they are personal, strategic, and time-sensitive. A two-phase approach recognises this reality. It gives buyers clarity earlier, respects sellers’ expectations, and supports a smoother, more predictable path to close.

Our goal is simple: to help you protect value, avoid surprises, and move through your deal process with clarity and confidence.

Please contact a member of the RSM Corporate Finance team if you have any questions about financial due diligence or navigating your deal with confidence