Due Diligence

Due Diligence: A Complete Practical Guide for Indian Transactions in FY 2026-27

Due diligence is the structured, multi-disciplinary investigation of a business, asset or counterparty before a significant transaction — equity investment, merger or acquisition, joint venture, lending or large supply contract. Done rigorously, it confirms or refines valuation, surfaces hidden liabilities and regulatory exposures, triggers price adjustments and shapes every material clause in the final deal document. In FY 2026-27, Indian deal markets have moved decisively past the checkbox approach: a 90-day close is only possible if due diligence is run as a tightly coordinated project from day one.

Why Due Diligence Is Not Optional

Every transaction you enter carries risks the other side either does not know about or prefers not to disclose. The gap between what a seller presents and what actually sits on the books is rarely zero. Common surprises include:

• Unrecorded employee liabilities — gratuity, leave encashment and bonus accruals that were never provisioned
• GST credit reversals owed under Rules 42 and 43 of the CGST Rules, 2017, for input tax credit (ITC) proportionately attributable to exempt supplies
• Pending income-tax assessments under Sections 143(3), 147 or 148A of the Income-tax Act, 1961 that have not yet crystallised into demand notices
• Litigation and contingent claims classified as "remote" in the notes to accounts but very much alive in court
• Related-party transactions executed at non-arm's-length prices that inflate margins and create recharacterisation risk

A well-run due diligence does five things: it confirms or reprices the valuation, identifies deal-breakers before you commit capital, surfaces the specific representations and warranties to demand in the Share Purchase Agreement (SPA), quantifies escrows and indemnities, and builds the integration blueprint. Skipping or rushing it in order to save fees is one of the most expensive decisions a buyer can make.

The Eight Types of Due Diligence You Need to Commission

Modern Indian transactions layer multiple streams of diligence. Here is what each one covers and why it matters.

1. Financial Due Diligence

This is the engine of the exercise. Its output — a "quality of earnings" (QoE) report — restates EBITDA after removing one-off items, related-party adjustments and accounting policy deviations. It also maps working capital movements and identifies every item that behaves like debt but does not appear on the debt schedule.

2. Tax Due Diligence

Covers direct taxes (income tax, minimum alternate tax, deferred tax assets), GST exposures (ITC eligibility, reverse charge, e-invoicing compliance, Annual Return filings on GSTR-9/9C), Tax Deducted at Source (TDS) compliance under Chapter XVII-B, and, for larger groups, transfer pricing documentation under Sections 92 to 92F of the Income-tax Act, 1961.

3. Legal and Secretarial Due Diligence

Reviews the company's constitutional documents — Memorandum of Association, Articles of Association — statutory registers, board and shareholder resolutions, MCA V3 filings (Forms MGT-7, AOC-4, DIR-12, SH-7), material contracts, leases, licences and pending litigation. For LLPs, it covers LLP Agreements, Form 11 (Annual Return) and Form 8 (Statement of Account and Solvency) on the MCA portal.

4. Commercial Due Diligence

Assesses the quality of the business itself: customer concentration (is more than 25–30% of revenue from one customer?), competitive dynamics, sustainability of pricing, market growth assumptions and channel risk.

5. HR and Labour Diligence

Maps the workforce to payroll, checks Provident Fund (PF) compliance on the EPFO unified portal, ESI registration and payment history, contract labour arrangements under the Contract Labour (Regulation and Abolition) Act, 1970, ESOP schemes and unvested obligations.

6. Technology and IP Diligence

Reviews software ownership, third-party licences, open-source usage (GPL contamination), data localisation obligations under the Digital Personal Data Protection (DPDP) Act, 2023, and cyber security posture — increasingly important after CERT-In's 6-hour incident reporting requirement.

7. ESG Diligence

Checks environmental clearances under the Environment (Protection) Act, 1986 and the EIA Notification, carbon footprint reporting for entities covered under the Business Responsibility and Sustainability Reporting (BRSR) framework, and governance practices — particularly audit committee independence.

8. Operational Diligence

Covers supply chain concentration, plant utilisation rates, committed capex, maintenance backlog and insurance adequacy. Critical for manufacturing and infrastructure assets.

The Standard Due Diligence Process: Six Steps from NDA to Close

A well-managed diligence exercise typically runs 45–90 days depending on deal size and complexity. Here is the sequence that keeps it on track.

1. Sign the NDA and receive the Information Memorandum (IM). The NDA should cover the buyer's advisors as well, not just the buyer entity. Confirm it has a residuals carve-out to avoid contaminating your proprietary knowledge base.

1. Issue the Due Diligence Request List (DDRL). A comprehensive DDRL spans all functional areas — financial statements for the last five years, tax returns (ITR), GST returns (GSTR-1, GSTR-3B, GSTR-9/9C), incorporation documents, material contracts, statutory registers, pending litigation schedules and environmental clearances. Issue it within five working days of receiving the IM.

1. Set up the Virtual Data Room (VDR). The seller populates the VDR against the DDRL. Access is role-restricted: financial advisors see financials and tax; legal advisors see corporate documents and contracts; both streams see the litigation schedule. A daily upload tracker prevents documents from being missed.

1. Conduct management Q&A sessions. These are structured sessions — typically one per stream — where advisors raise queries directly with the CFO, legal counsel and functional heads. Site visits or plant tours are conducted in parallel for operational diligence.

1. Prepare the draft due diligence report. Each stream produces a report graded by severity: showstoppers, material price-adjustment items, post-deal action points and informational observations. A consolidated report is then presented to the deal committee.

1. Confirmatory diligence closer to signing. In the 10–15 days before signing the SPA, the advisors confirm that no new material events have occurred — a fresh Companies Act search on MCA V3, a check for fresh GST demand orders and a litigation update from the company's legal counsel.

Financial Due Diligence: Understanding Quality of Earnings

The headline EBITDA in a company's books is rarely the number you should pay on. Financial due diligence (FDD) reconstructs a normalised, sustainable EBITDA by adjusting for:

• One-off income: Insurance claims, asset sale gains, government grants accounted above EBITDA
• Below-market related-party costs: Management fees, rent or services from promoter entities at non-arm's-length rates
• Accounting policy differences: Deferred maintenance expenses, aggressive revenue recognition on milestone contracts
• Under-provisioned liabilities: Gratuity, warranty reserves, doubtful debts

After normalising earnings, FDD maps the working capital peg — the level of net working capital a buyer needs the business to have at closing. A shortfall at closing date triggers a downward price adjustment; a surplus may be returned to the seller. This is arguably the clause most argued over at signing.

Debt and debt-like items is a separate schedule. Beyond bank loans and debentures, it captures deferred payment liabilities, security deposits held by customers (which are economic debt), employee benefit deficits, and any earnout or contingent consideration from prior transactions. Each rupee on this list reduces the equity value the buyer pays.

Tax Due Diligence in India: Where Most Deals Hit Trouble

Tax diligence is consistently the stream that produces the largest quantified adjustments in Indian deals. Four areas deserve your closest attention.

Income Tax: Pending Assessments and Reopening Risk

Check the income-tax login on the e-filing portal (incometax.gov.in) for all open assessment years. Under Section 148A of the Income-tax Act, 1961, the Assessing Officer must issue a show-cause notice before reopening an assessment, but older demands may still be pending before the Commissioner of Income Tax (Appeals) or the Income Tax Appellate Tribunal (ITAT). Any demand above your materiality threshold (typically Rs. 25–50 lakh for mid-market deals) must be reviewed, and the probability of outcome modelled.

GST: ITC Reversal and E-Invoicing Exposure

For businesses with both taxable and exempt supplies, Rule 42 of the CGST Rules, 2017 mandates pro-rata reversal of ITC on common inputs. Many companies have not computed or reversed this correctly. Three years of un-reversed ITC at even a modest scale creates significant exposure: principal, interest at 18% per annum under Section 50 of the CGST Act, 2017, and a potential penalty of up to 100% of the tax short-paid.

E-invoicing (e-invoice) applicability thresholds have been progressively reduced. As of FY 2026-27, e-invoicing applies to all registered persons with aggregate turnover above Rs. 5 crore in any preceding financial year. Verify that every B2B invoice in the review period was either e-invoiced or fell within the then-applicable threshold. Mismatches surface in GSTR-2B reconciliations.

TDS Compliance

Check for deductions under high-frequency sections: 194C (contractors, 1%/2%), 194J (professional/technical fees, 2%/10%), 194H (commission, 5%) and 194Q (purchase of goods above Rs. 50 lakh, 0.1%). Non-deduction triggers disallowance under Section 40(a)(ia) — up to 30% of the relevant expense — plus interest under Section 201(1A) at 1.5% per month from date of payment to date of deduction.

Transfer Pricing

If the target has international related-party transactions or Specified Domestic Transactions above the thresholds under Section 92BA, verify that contemporaneous transfer pricing documentation under Section 92D was maintained. Penalties for failure to maintain or report documentation range from 2% of the value of each international transaction under Section 271AA.

Setting Up a Virtual Data Room: The 12-Folder Structure That Works

A well-structured VDR eliminates the most common diligence delay: "we cannot find that document." Use this folder architecture:

1. Incorporation and corporate structure
2. Statutory registers and MCA V3 filings (Forms MGT-7, AOC-4, DIR-12)
3. Financial statements and auditor reports (5 years)
4. Income-tax returns (ITR-6) and assessment orders (5 years)
5. GST returns (GSTR-1, GSTR-3B, GSTR-9, GSTR-9C) and notices (3 years)
6. TDS/TCS returns (Form 26Q, 27Q) and challans
7. Material contracts (customer, vendor, lease, IP, employment)
8. Litigation and regulatory notices
9. Intellectual property (trademark registrations, patent filings, software agreements)
10. HR, payroll, PF/ESI, gratuity actuarial report, ESOP documents
11. Environmental clearances, factory licences, pollution control certificates
12. Management presentations, cap table, shareholder agreements

Assign each advisor team read-only access to the folders relevant to their scope. Maintain a version log so that a document uploaded on Day 12 is clearly distinguishable from the version uploaded on Day 1.

Worked Example: How Due Diligence Saved Rs. 1.8 Crore on a Rs. 12 Crore Deal

A strategic buyer offers Rs. 12 crore for a mid-market manufacturing company, based on an EBITDA of Rs. 2 crore and a 6× multiple. FDD and tax diligence over 45 days uncover the following:

Outcome: The buyer adjusts the enterprise value downward by Rs. 1.2 crore — reducing the offer to Rs. 10.8 crore — and inserts a specific indemnity in the SPA for the GST exposure with a Rs. 60 lakh escrow held for 18 months. The revenue overstatement flows into a closing date working capital adjustment. The seller, informed in advance by a proactive advisor, had already set aside funds, so the deal closes in a further 30 days.

This is the return on investment for a Rs. 10–15 lakh diligence fee.

Red Flags That Should Make You Pause — or Walk Away

Not every diligence finding is a price-adjustment item. Some findings warrant a pause; a few justify walking away.

Showstoppers:

• Criminal proceedings against promoters or key managerial personnel (KMP) under the IPC, Prevention of Corruption Act or PMLA
• Regulatory disqualification or debarment affecting the target's primary licence
• Fraudulent financial statements — evidence of revenue fabrication or fictitious customers

Major price-adjustment items:

• Unrecorded contingent liabilities above 15% of deal value
• Customer concentration where one customer represents more than 30% of revenue and has no long-term contract in place
• Significant off-balance-sheet arrangements — operating leases pre-Ind AS 116 transition, or supply-or-pay contracts that create future obligations

Watch-and-mitigate:

• Promoter loans and pledge of shares in the target or group companies — assess post-deal control implications under SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 where applicable
• Pending regulatory actions from sector-specific authorities (FSSAI, Drug Controller, AERB, TRAI)
• High attrition among senior technical staff immediately before the deal

Common Mistakes and Pitfalls to Avoid

Even experienced deal teams make these errors — often under time pressure.

1. Treating the scope as fixed after Day 1. Diligence is iterative. A finding in the financial stream may expand the tax scope, and a legal finding may require additional financial analysis. Build a change-of-scope mechanism into your engagement letter.

2. Accepting management representations without document backup. "We have never received a GST notice" is not a diligence finding — a printout from the GST portal confirming no outstanding notices is.

3. Ignoring the Annual Information Statement (AIS) and Tax Information Summary (TIS). For FY 2024-25 and FY 2025-26, the AIS on the income-tax portal aggregates third-party data: bank credits, GST turnover reported by counterparties, property transactions, share transactions. Cross-reference the target's AIS against its filed ITR-6. Unexplained gaps indicate unreported income or under-reporting.

4. Skipping the confirmatory diligence step. A material litigation filed or a fresh GST demand received in the 30 days between submission of the diligence report and signing will not appear in the report. Always do a fresh portal sweep immediately before signing.

5. Conflating EBITDA multiple with equity value. Enterprise value equals equity value plus debt and debt-like items, minus cash. Many first-time buyers compare an EBITDA-based enterprise value with the equity consideration without deducting debt — an error that can run into crores on a leveraged target.

6. Not verifying MCA V3 compliance status independently. Corporate filings on MCA V3 are self-certified. Cross-check by downloading the company's master data, charge index and director information directly from the MCA portal rather than relying on company-provided summaries.

Vendor (Seller-Side) Due Diligence: Preparing Before You Go to Market

A well-prepared seller controls the narrative. Vendor due diligence (VDD) — where the seller commissions their own financial and legal review before receiving buyer queries — delivers four tangible benefits:

• Prevents valuation chipping. Issues discovered by a buyer mid-process become leverage for a price reduction. Issues you already know about and have remediated or disclosed upfront cannot be used the same way.
• Compresses the timeline. If the VDR is pre-populated with a clean, structured data room and a draft financial diligence report, the buyer's advisors can complete their review in 30 days instead of 60.
• Builds credibility. A seller who proactively discloses an old tax demand and shows the CIT(A) order in their favour signals transparency, which builds trust and protects representations given in the SPA.
• Improves deal certainty. Fewer surprises mean fewer conditions precedent, fewer re-negotiations, and a lower probability of a deal falling apart post-term sheet.

Companies that expect a fundraise or sale process in FY 2026-27 should ideally begin their VDD at least six months ahead, allowing time to remediate GST filing gaps, clear pending TDS defaults on TRACES, file overdue MCA forms (with applicable additional fees), and obtain a fresh actuarial valuation for gratuity and leave encashment.

Translating Diligence Findings into SPA Terms

Every material finding should map to a specific contractual mechanism in the SPA or Share Subscription Agreement (SSA).

• Specific indemnities for identified tax demands, regulatory penalties and litigation with separate caps and baskets, isolated from the general representations and warranties cap
• General representations and warranties covering financial statements accuracy, absence of undisclosed liabilities, compliance with applicable laws — typically with a survival period of 18–36 months post-closing
• Purchase price mechanism — a locked-box or completion accounts mechanism that adjusts consideration for actual net working capital, net debt and cash at the closing date against agreed pegs
• Conditions precedent for regulatory consents required before closing: Competition Commission of India (CCI) approval where applicable, Reserve Bank of India (RBI) reporting under FEMA for cross-border deals, SEBI open offer obligations where the Takeover Code is triggered
• Escrow arrangement — typically 10–15% of equity consideration held in escrow for 12–24 months to secure indemnity claims

The diligence issues log — maintained throughout the exercise — becomes the working draft of the indemnity schedule. A disciplined issues log built during diligence shortens SPA negotiations by weeks.

Key Takeaways

• Due diligence is a risk quantification exercise, not a compliance formality — every stream should produce a monetised output that feeds into price or documentation.
• In FY 2026-27, tax diligence — especially GST ITC reversals and TDS defaults — consistently produces the largest quantified adjustments in Indian mid-market deals.
• Cross-reference the target's AIS/TIS on the income-tax portal and the GST portal's demand-and-liability tab against filed returns; gaps cannot be explained away.
• A well-structured 12-folder VDR with role-based access and a daily upload tracker eliminates the single biggest cause of diligence delay: missing documents.
• Confirmatory diligence in the 10–15 days before signing is non-negotiable — it catches events that occurred after the main report was issued.
• Vendor due diligence begun six months before a process gives sellers the time to remediate issues rather than disclose them under pressure, preserving valuation and deal certainty.
• Every finding maps to a contractual mechanism: specific indemnity, general rep and warranty, price adjustment, escrow or condition precedent — the diligence team and the legal team must stay in constant dialogue throughout.