M&A Due Diligence Checklist: Financial, Tax, Legal and Operational Review (2026)

An M&A due diligence checklist is the list of documents, analyses and questions a buyer works through before closing an acquisition. It covers four workstreams: financial (including a quality of earnings review), tax, legal and operational. Each item on the list should either confirm the price in the letter of intent, change it, or move a risk into the purchase agreement through an indemnity, escrow or specific representation.

This M&A due diligence checklist is written for owners preparing to sell, buyers of lower middle market companies, and CPA firms supporting either side. It reflects rules in force in October 2026, including the One Big Beautiful Bill Act (OBBBA) tax changes and the 2026 Hart-Scott-Rodino filing thresholds. If the deal is a property purchase rather than a company, the real estate due diligence checklist for property buyers covers title, survey and lease items that this guide leaves out.

How to Use This M&A Due Diligence Checklist

Diligence normally starts once the letter of intent is signed and the seller opens a virtual data room. Findings from each workstream feed the valuation model, the purchase agreement and the integration plan.

Assign an owner to every workstream on day one and keep a single tracker of requests and their status. Sellers who build that tracker before going to market, much like a startup preparing its finances for investor due diligence, usually close faster because the buyer spends less time chasing documents.

Financial Due Diligence Checklist

The financial workstream tests whether the marketing numbers match the books, and the books match the bank. Request at least three years of history plus the current year to date.

Historical statements and reporting

• Annual financial statements for three years, with the audit, review or compilation report attached. Our guide to audit, review and compilation differences explains what each one tells a buyer.
• Monthly trial balances and management accounts for the trailing 24 months.
• General ledger detail, bank statements and bank reconciliations for the same period.
• Auditor management letters and any restatements.

Revenue and customers

• Revenue by customer, product and location, with the top 10 customers shown as a share of total.
• Revenue recognition policy under ASC 606, deferred revenue roll-forward and backlog.
• Customer contracts with change-of-control, exclusivity or termination-for-convenience clauses.
• Credit memos, returns and rebates issued after each year end.

Working capital and cash

• Accounts receivable and payable aging at each month end.
• Inventory counts, costing method and obsolescence reserve.
• A monthly net working capital schedule to set the closing peg. The mechanics are the same ones covered in our working capital management strategies guide.
• Proof of cash that ties reported revenue to bank deposits.

Debt and debt-like items

• Loan agreements, lines of credit, equipment leases and covenant compliance certificates.
• Accrued but unpaid bonuses, deferred compensation, customer deposits, unpaid tax and deferred rent. Buyers usually treat these as debt-like and deduct them from the price.
• Guarantees, letters of credit and off-balance-sheet commitments.

Quality of Earnings: What the Report Tests

A quality of earnings (QoE) report restates EBITDA to show what the business earns on a normal, recurring basis under the buyer's ownership. Most lower middle market deals are priced as a multiple of adjusted EBITDA, so each dollar of adjustment moves the price by the multiple.

A QoE review usually covers four tests:

1. Proof of revenue and cash. Ties revenue to invoices and deposits and flags any month where they diverge.
2. Normalization adjustments. Removes one-time items and resets owner pay, related-party rent and other non-market terms to market rates.
3. Accounting corrections. Moves the books from cash basis or loose accrual practice to full accrual so expenses land in the right period.
4. Run-rate and pro forma items. Adds the full-year effect of price increases, new contracts or lost customers. Buyers accept these less readily.

The SEC's guidance on non-GAAP measures offers a useful discipline even for private deals. The staff states that a measure that "excludes normal, recurring, cash operating expenses necessary to operate a registrant's business" could be misleading, and it views an expense that occurs "repeatedly or occasionally, including at irregular intervals" as recurring (SEC non-GAAP interpretations). A buyer's QoE team applies the same test to yearly "one-time" add-backs.

Worked Example: Adjusting EBITDA in a Quality of Earnings Review

The figures below are illustrative. Harbor Supply Co., a distributor, reports trailing twelve month EBITDA of $2,400,000. The buyer's offer uses a 6.0x multiple, also illustrative. The QoE team proposes five adjustments.

Adjusted EBITDA is $2,400,000 + $200,000 + $120,000 - $90,000 - $80,000 + $95,000 = $2,645,000, about 10.2% above the reported figure. At 6.0x, the headline value rises from $14,400,000 to $15,870,000, a difference of $1,470,000.

The ERP add-back is where negotiation usually happens. If the buyer shows the company spends on system projects every few years and rejects the $95,000, adjusted EBITDA falls to $2,550,000 and value at 6.0x falls to $15,300,000. That single line is worth $570,000 of price. The rent and bonus adjustments cut against the seller, and a sell-side QoE lets the seller deal with all of these items before a buyer raises them.

For a full valuation build around adjusted EBITDA, see our guide to financial modeling for business valuation, which works through a DCF alongside the multiple method.

Tax Due Diligence Checklist

As general information, tax exposure usually stays with the legal entity in a stock purchase, so the buyer indirectly takes on the target's open years. In an asset purchase, historic income tax generally stays with the seller, although sales tax, payroll tax and state successor liability rules can still reach the buyer. The right structure depends on the facts of each deal and should be confirmed with a tax adviser.

Open years and filings

• Federal, state and local income tax returns for every year still open. The IRS period for assessing additional tax is generally 3 years, extends to 6 years if income above 25% of the gross income shown was left off, and keeps the period open indefinitely where no return or a fraudulent return was filed (IRS record-keeping periods). Our article on how far back the IRS can audit explains each period.
• IRS and state notices, audits and payment plans.
• Payroll tax filings (Forms 941 and 940) and worker classification for contractors.

State and indirect tax

• Sales and use tax registrations compared against where the company actually sells. A target that crossed state thresholds without registering may owe uncollected tax, and the economic nexus rules for growing businesses show how quickly that liability builds.
• State income tax and franchise tax filing footprint.

Structure and tax attributes

• Entity type and tax elections. Where a structure depends on the target's S corporation status, such as a section 338(h)(10) election or an F reorganization, buyers commonly review whether the S election has been valid since it was made, because an invalid election can change the expected tax result.
• Net operating losses, credits and deferred tax balances, including whether any valuation allowance was assessed properly.
• Purchase price allocation. In an asset deal, "both the seller and purchaser of a group of assets that makes up a trade or business must use Form 8594" when goodwill or going concern value attaches, or could attach, to the assets and the buyer's basis is set only by the amount paid (IRS Form 8594). The agreed allocation drives the buyer's depreciation and the seller's character of gain. Goodwill and other acquired intangibles are generally amortized over 15 years, as covered in our Section 197 amortization guide.

OBBBA changes to model in 2026

• The OBBBA (P.L. 119-21) provides "a permanent 100-percent additional first year depreciation deduction for qualified property acquired" after January 19, 2025. The IRS issued interim guidance on the deduction and the related elections in Notice 2026-11 in January 2026 (IRS bonus depreciation guidance). In an asset deal, the part of the price allocated to qualifying tangible property, such as equipment, may be eligible for the deduction in the year it is placed in service.
• For tax years beginning after 2024, the OBBBA again allows depreciation, amortization and depletion to be added back when computing adjusted taxable income for the section 163(j) business interest limit, an EBITDA-style measure (IRS Form 8990 instructions). Domestic research or experimental expenditures paid or incurred in tax years beginning after 2024 can again be deducted under section 174A (IRS Rev. Proc. 2025-28). Both matter for a leveraged buyer modeling post-close cash taxes.

Legal Due Diligence Checklist

Counsel leads legal diligence, though many findings carry a dollar value.

• Corporate records: formation documents, ownership ledger, option and equity grants, board minutes.
• Material contracts: customer, supplier, license and lease agreements, with attention to change-of-control consent, assignment limits and most-favored-customer pricing.
• Litigation and claims: pending and threatened suits, demand letters, settlements in the last five years, and the reserve recorded for each.
• Intellectual property: registered marks and patents, invention assignment agreements from employees and contractors, and open-source software use.
• Employment: offer letters, non-competes, severance and retention agreements, benefit plan documents and any change-of-control bonuses.
• Regulatory filings: licenses, permits and whether the deal requires antitrust notification.

HSR Premerger Notification Thresholds for 2026

For 2026, the Federal Trade Commission raised the size-of-transaction threshold for Hart-Scott-Rodino reporting from $126.4 million to $133.9 million, effective February 17, 2026 (FTC notice in the Federal Register). Once a filing is complete, the parties wait 30 days before closing, or 15 days for a cash tender offer or bankruptcy. The same notice sets the 2026 filing fees by deal size:

Deals between $133.9 million and $535.5 million are reportable only if the parties also meet the size-of-person tests. Most lower middle market deals, including the $15.9 million Harbor Supply example, fall well below the threshold and need no filing. A federal district court vacated the expanded HSR form introduced in February 2025, and the vacatur took effect on March 19, 2026, after the appeals court declined to stay it. The FTC now accepts filings on the form that was in place before February 10, 2025, and in March 2026 the FTC and DOJ asked for public comment on changes to the form, so counsel should confirm the current form before preparing a filing.

Operational Due Diligence Checklist

Operational diligence asks whether the business will perform the same way once the seller steps back.

• Management and people: organization chart, key-person dependence, turnover by department and open roles.
• Systems and controls: accounting software, ERP, access rights and segregation of duties. A short round of internal controls testing on cash disbursements and revenue cut-off often explains QoE findings.
• Supply chain: supplier concentration, single-source parts, freight terms and tariff exposure.
• Facilities and equipment: condition, deferred maintenance and capital expenditure needed in the first two years. Underspending on capex inflates EBITDA, so compare capex to depreciation over several years.
• Insurance: current policies, claims history and whether coverage continues after a change of control.

Accounting Items That Carry Into Closing

The buyer's own books change on the closing date. Under ASC 805, the acquirer records the assets acquired and liabilities assumed, and since ASU 2021-08 it applies Topic 606 to "recognize and measure contract assets and contract liabilities in a business combination" instead of fair value (FASB ASU 2021-08). For private companies this applies to fiscal years beginning after December 15, 2023, so deferred revenue diligence feeds the opening balance sheet. Our ASC 805 business combinations guide covers the full acquisition method, and any goodwill recorded is later subject to the goodwill impairment test.

After closing, our post-merger integration checklist picks up from here.

Red Flags That Should Pause a Deal

In practice, these findings often justify a price change or a specific indemnity:

• Revenue that rises while cash collections stay flat or fall.
• A single customer above roughly 20% of revenue without a long-term contract (a common rule of thumb, not a regulatory limit).
• Add-backs that appear every year under a new label.
• Sales tax collected in fewer states than the company ships to.
• Bank reconciliations that are months behind.
• Debt-like items, such as customer deposits or unpaid bonuses, that the seller wants excluded from the price.

Frequently Asked Questions

What should an M&A due diligence checklist include? It should cover financial, tax, legal and operational workstreams. Each section lists the documents to request and the questions each answer should settle.

What is a quality of earnings report? A quality of earnings report restates EBITDA to show recurring, normalized profit. Buyers use the adjusted figure to set the price.

How long does M&A due diligence take? For a lower middle market company, buyers commonly plan for 45 to 90 days from signing the letter of intent. This is practitioner guidance, and the timeline depends mainly on how quickly the seller fills the data room.

Does my acquisition need an HSR filing in 2026? A filing is generally required when the transaction is valued above $133.9 million, the 2026 threshold that took effect on February 17, 2026, subject to size-of-person tests for deals up to $535.5 million. Filing fees start at $35,000. Confirm reportability with antitrust counsel.

Next Step

Madras Accountancy supports buyers, sellers and CPA firms with the accounting work behind a deal, including ledger cleanup before a sale, financial analysis for diligence, tax preparation and CFO-level advisory. To talk through an upcoming transaction, contact our team.