How to prepare a due diligence report

Due diligence reports provide the insights that organizational leaders need before making major business decisions. 

Whether you expect to create one or be the subject of one, here’s what you should know about these reports, including how they work, the different types, and how to prepare them.

What is a due diligence report?

A due diligence report is a compilation of the insights gained from an in-depth investigation, often into a specific aspect of a company. For example, the subject of a due diligence report might be a startup’s finances or operations.

Such documents are typically the result of a formal due diligence process. These usually occur when one party wants to evaluate the risks involved in a significant decision before committing, such as an investment or M&A transaction.

Types of due diligence reports

Due diligence reports can take many different forms depending on the type of assurance they’re meant to provide. Let’s explore some of the variations that you’re most likely to encounter.

Financial due diligence report

A financial due diligence report provides insight into the accuracy of a company’s accounting records and the strength of its financial performance. 

Creating one primarily involves reviewing the financial statements—balance sheet, income statement, and cash flow statement—along with supporting documentation.

To learn about being the subject of financial due diligence, read our article, How to Prepare for a Financial Audit.

Legal due diligence report

A legal due diligence report provides insight into a company’s legal affairs. 

In addition to reviewing its litigation history and pending lawsuits, it may include an examination of matters like the company’s contracts, intellectual property rights, and regulatory compliance record.

Operational due diligence report

An operational due diligence report provides insight into the day-to-day tasks that keep a company functioning, often to help gauge efficiency and identify bottlenecks that might hinder growth. 

For example, creating one might involve reviewing a business’s workflows, internal controls, and technological systems.

Commercial due diligence report

A commercial due diligence report provides insight into a company’s positioning in the competitive landscape, typically including an assessment of its current market share and growth prospects. 

Creating one requires an analysis of factors like the company’s business model, customer base, main competitors, and pricing strategy.

How to prepare a due diligence report

Startups are often the subject of a lender or investor’s due diligence, in which case they would generally prepare the report, not you. 

However, learning how the process works will help you understand your role in it, and you never know when you may need to conduct the process yourself. Here’s what it usually entails.

Step 1 – Gather all relevant documents and information

The first step in preparing a due diligence report is to collect the materials that will form the foundation of your analysis. In other words, you need to put together the factual basis for evaluating whatever aspect of the company you’re studying.

The specific documents you need will depend on the type of investigation you’re performing, but you can often expect a due diligence checklist to contain:

• Financial records: Examples include financial statements, general ledgers, a list of outstanding debts and creditors, a list of shareholders and their ownership percentages, tax returns for the last three years, correspondence with tax authorities, stock options and plans, a quality of earnings report, loan and credit agreements, and budgets.
• Legal and corporate documents: Examples include incorporation papers, shareholder agreements, major contracts with customers and suppliers, leases and mortgages, terms of settlements, intellectual property rights, and any ongoing or past litigation records.
• Operational and HR information: Examples include organizational charts, process documentation, key job descriptions, employment agreements, benefits policies, internal control procedures, information technology (IT) infrastructure, and supply chain reports.
• Market and competitor research: Examples include market analysis reports, growth projections, SWOT analyses, customer lists and sales data, customer satisfaction surveys, pricing models by product line, competitor analyses, and marketing campaign plans.

Once you’ve collected all the relevant information, often via a diligence questionnaire, make sure to organize everything systematically. This will help you reference individual documents more efficiently and make it easier to identify gaps in your knowledge base.

Step 2 – Review and verify the gathered documentation

Once you’ve collected your initial materials, the next step is to confirm their accuracy and completeness. This ensures your due diligence is rooted in reliable information rather than potentially misleading data.

Start by reviewing each document for consistency, such as by cross-checking names, dates, and figures across records. For example, you might verify that shareholder ownership percentages on the cap table match those in the corporate filings.

If you’re performing financial due diligence, you’ll want to do something similar for the gathered financial records. For example, confirm that all information in the financial statements ties to the underlying source data, such as invoices and bank statements.

For legal documents, the verification process is often less about reconciling numbers and more about confirming validity. 

For example, this might involve checking that contracts were properly executed, expiration dates are current, and terms comply with relevant regulations.

You should also consider the timeliness of the information. Any document that’s more than a year old may no longer reflect current conditions. Always request the most recent versions and note any missing or incomplete data.

If your due diligence includes reviewing any external information, make sure to validate its credibility as well. For example, confirm that the sources behind any outside market research or competitor data are reputable.

Always maintain a record of your verification processes. Documenting how you confirmed accuracy strengthens the reliability of your due diligence reporting and helps provide transparency if readers have questions later.

If your company is ever the subject of a due diligence report, Zeni’s AI-powered bookkeeping can keep your financial statements accurate, up to date, and GAAP-compliant, ensuring they’re always ready for review.

Step 3 – Identify potential risks and liabilities

Once you’ve verified the accuracy of your documentation, the next step is to comb through it and identify potential risk areas. This is where you move from confirming facts to searching for red flags that could threaten the prospective deal.

When performing a financial review, you’ll typically be looking for anything that could undermine profitability or the continuation of the business. For example, that might include excessive debt, declining profit margins, or cash flow issues.

If you’re performing a legal review, finding potential risks is often more straightforward. For instance, unresolved legal disputes and contracts with restrictive terms like exclusivity clauses are clear examples of liabilities.

In an operational review, you’ll often want to search for inefficiencies and potential vulnerabilities. Examples might include high employee turnover, overreliance on key managers, or weak internal controls that could impact scalability.

Identifying risks during commercial due diligence may require more critical thinking, as there are often more variables and fewer concrete answers. For example, one potential liability might be overreliance on a single product offering.

As you work through this process, it’s often a good idea to quantify the significance of each risk. This will help you determine which issues to prioritize in future analysis and which are minor concerns that probably won’t affect the prospective deal.

Step 4 – Identify strengths and opportunities

Due diligence is just as much about confirming strengths as it is about uncovering potential weaknesses. After all, if you’ve reached this stage, you’re likely evaluating a business you already believe has promise.

When conducting financial due diligence, look for indicators of stability and growth potential. For example, consistent revenue growth, healthy margins, and diversified income streams might suggest a strong financial foundation.

That said, keep in mind that financial strength and potential may look different depending on the type of company and its growth stage, especially for startups.

When performing legal due diligence, look for factors that indicate low risk of future litigation and other legal issues. For example, some strengths may include robust intellectual property protections or a history of regulatory compliance.

In operational efficiency due diligence, your goal is to identify what the company does well. Consider looking for especially efficient processes, effective leadership, or anything else that points to operations being capable of supporting future growth.

Lastly, for commercial due diligence, pay special attention to any competitive advantages, such as a loyal customer base or unique product. These strengths often represent the company’s most valuable assets and help justify its valuation.

As you did with the risks you discovered in the previous step, it’s often beneficial to summarize the opportunities you’ve identified and highlight the most significant ones for further investigation.

Step 5 – Conduct a thorough analysis of key findings

Once you’ve identified the subject’s risks and strengths, the next step is to analyze them thoroughly. This is where you move from listing initial observations about the company to making informed conclusions.

Start by assessing the severity of each risk you identified, beginning with those you flagged as most notable upfront. Consider how likely each issue is to occur and what the effects would be if it were to manifest.

Next, weigh the company’s strengths against those weaknesses. The goal is to form a balanced view that reflects both upside and downside potential. A business with strong fundamentals and only a few manageable risks may still be an attractive prospect. 

Look for connections between your various findings. For example, operational inefficiencies might explain financial underperformance. Identifying these relationships helps you understand the bigger picture rather than treating each issue in isolation.

Whenever possible, quantify your analysis. Estimate the potential financial impact of key risks and the value of specific opportunities. Even rough calculations can help you weigh trade-offs more effectively.

This is another area where Zeni can be invaluable if you’re ever the subject of due diligence. Its AI-powered dashboards can calculate key performance indicators (KPIs) in real time and provide financial insights that make analysis faster and more thorough.

Step 6 – Structure and write the due diligence report

Once your analysis is complete, the last step is to organize your findings into a professional report. It should be structured in a way that makes the sensitive information easy to navigate and supports informed decision-making.

Fortunately, you don’t have to create the structure from scratch, as you can easily find a due diligence report template online. Even if you don’t copy it exactly, reviewing examples can help you understand how they should look.

If you do follow a template, make sure it comes from a credible source—such as a reputable financial, legal, or consulting firm—and that it matches the type of due diligence you performed.

Keep in mind that preparing a due diligence report isn’t always something you need to do in‑house. The process can be time‑consuming and complex, requiring investigative expertise and subject‑matter knowledge in areas like accounting, law, or compliance.

In many cases, it’s more efficient to outsource the work to a specialist diligence team or advisory firm. Doing so saves time and helps ensure accuracy, which is essential when the findings will influence major financial or strategic decisions.

What to include in a due diligence report

While the specific contents of your report will depend on the type of due diligence you’re performing, most share some similar components. Here’s what you should usually include when following best practices:

• Executive summary: This is a concise overview of the purpose, scope, and key findings of the review. It should highlight the most important information so readers can quickly grasp the company overview.
• Main body: This section contains the core of your analysis, whether that’s financial, legal, operational, or commercial. Typically, you’ll present both the factual data and your interpretation of it.
• Risk assessment: This is a focused recap of the major risks identified, categorized by severity and likelihood. This helps readers assess any significant issues that might threaten the prospective deal at a glance.
• Opportunity summary: A counterpart to the risk section, this outlines the company’s competitive advantages and biggest opportunities for growth or improvement. It ensures your report provides a complete and objective view of the company.
• Supporting documentation: Consider including references or appendices with any critical supporting information the reader may need. These materials provide transparency and help readers to verify your conclusions for themselves.

Common mistakes to avoid when preparing due diligence reports

Preparing a comprehensive due diligence report can be a long and complex process, leaving plenty of room for mistakes. Here are some of the most common pitfalls you should know to watch out for along the way.

Incorrect investigative scope

One of the most dangerous errors you can make is to define the scope of your due diligence too narrowly or too broadly. 

In other words, don’t focus exclusively on finances when operations are also critical—but don’t waste resources investigating legal matters when they’re irrelevant either. Tailor your scope to the specific context of the deal.

Insufficient verification of information

Always confirm that the data you’re working with is both accurate and up to date. Cross‑check figures, validate documentation, and ensure that any third‑party information comes from reliable sources before you start drawing any conclusions.

Overlooking hidden liabilities

The data you receive may appear factual and positive, but concealed issues could change the picture entirely. Look for inconsistencies, unexplained omissions, or vague contract terms that could hide obligations or risks.

Overlooking lower‑profile risks

It’s easy to focus on the most obvious red flags, but seemingly smaller issues can sometimes have larger implications. A liability that appears minor at first glance could prove significant later, so make sure you assess every potential risk.

If you’re ever the subject of financial due diligence, Zeni’s automated systems can help prevent simple errors in your accounting records that could derail the process, like misclassified expenses or incomplete records.

Get help with due diligence from Zeni

The due diligence review process can be exhaustive, whether you’re the subject of the report or the one preparing it. Fortunately, you don’t have to handle it alone. 

Zeni’s comprehensive financial management platform, fractional CFO services, and flexible AI agents can simplify every step—no matter which side of the transaction you’re on. Schedule your free demonstration today.