Due Diligence in Practice – Risk and Value Verification

M&A Process Guide Series 3/5

Executive Summary

Due Diligence is a critical step in M&A transactionsthat resolves information asymmetry andestablishes the basis for investment decisions. Through this process, the buyer verifies the target company's intrinsic value, uncovers hidden liabilities and potential risks, and ultimately determines the appropriateness of the transaction price. This content presents an example of a Due Diligence framework structured across six major domains (Financial, Commercial, Legal, Operational, Tax, HR/ESG) as applied by Corp Dev or Investment Strategy (Deal) teams at actual companies like O and S during deal execution.

A significant portion of M&A deal failuresresult from either failing to identify key risks during the Due Diligence phase or failing to respond appropriately to identified risks.Research and experience show an inverted U-shaped relationship between time to close and post-M&A performance
— deals with thorough due diligence within an appropriate timeframe yield the best results, while deals that are too fast (due diligence deficiencies) or too slow (overdue) both face higher failure probabilities.¹

As of 2026, the scope of due diligence extends beyond traditional financial and legal domainsto encompass cybersecurity, ESG, AI governance, and data compliance. Particularly with the acceleration of the digital economy, the evaluation ofa target company'sdata assets, compliance with personal information protection regulations,andthe ethical use of AI systemshave emerged as new deal breakers.

• [Key Conclusions]
  • The optimal due diligence period is 4-8 weeks; exceeding this risks losing deal momentum and increasing the risk of information leakage.²
  • EBITDA Adjustments typically cause fluctuations of ±15-30% relative to Reported EBITDA, which directly impacts valuation.³
  • 
    Primarily categorized into three types:Legal/Compliance Risk, Financial Misrepresentation, and Cultural Incompatibility
  • Over 70% of post-closing surprises were issues already identified during due diligence but ignored.⁴

---

I. Strategic Design of Due Diligence: Scope, Team, Timeline

1.1) Purpose and Core Principles of Due Diligence

Due Diligence is not merely a "document review process." Itis a strategic process for validating the investment thesis, identifying value creation opportunities, and quantifying transaction risks.

• The Four Major Purposes of Due Diligence
  1. Value Validation:Verifying whether the financial performance and growth narrative presented by management align with reality.
  2. Risk Discovery:Identifying contingent liabilities, legal disputes, and operational vulnerabilities not reflected in financial statements
  3. Synergy Verification:Assessment of the feasibility of achievable cost savings and revenue synergies following an acquisition
  4. Securing Negotiation Leverage:Price adjustments or contract term improvements based on identified issues

Practical Principle – "Trust but Verify"

The fundamental principle of Due Diligence is "Trust, but verify."
Use the information provided by the seller's management as a starting point, but confirm the facts through independent verification.
According to McKinsey research, 85% of successful M&A deals were transactions wherethere was ahighdegree of consistency between Management Representations and the findings of Due Diligence.⁵

1.2) Setting the Scope of Due Diligence: Risk-Based Approach

Reviewing all areas with the same depth is inefficient. In practice,a Risk-Based Approachis adopted, focusing on the deal's key value drivers and potential risk areas.

Scope Setting Framework (Example – Mid-sized Manufacturing Company ABC)

Priority	Due Diligence Area	Focus conditions	Example
First priority	Financial Due Diligence	All transactions	EBITDA Adjustment, Working Capital
First priority	Legal Due Diligence	All transactions	Contract review, litigation status, regulatory compliance
Second priority	Commercial Due Diligence	Growth-based investment	Market size, customer concentration, competitive analysis
Second priority	Tax Due Date	Complex structure, Cross-border	Deferred Corporate Tax, Transfer Pricing
Third priority	Operational Due Diligence	Investment in Operational Improvements	Supply chain, manufacturing efficiency, IT systems
Third priority	HR/ESG Due Diligence	Labor-intensive industries, regulated industries	Labor disputes, environmental responsibility, governance

• Empirically Key Areas by IndustryIt was as follows.
  • Software/SaaS:IP/Technology Due Diligence (Source Code Review, License Review), Customer Churn Rate Analysis
  • Manufacturing:Operational Due Diligence (equipment obsolescence, operating rates), Environmental Due Diligence (pollution liability)
  • Bio/Healthcare:Regulatory Due Diligence (licensing status, FDA approval), Compliance Due Diligence (HIPAA, personal information)
  • Retail:Commercial Due Diligence (Store Profitability, Lease Agreements), Inventory Due Diligence (Inventory Valuation)
  • Financial Services:Regulatory Due Diligence (Licensing, Capital Regulations), Credit Due Diligence (Loan Portfolio Quality)

1.3) Due Diligence Team Composition: Cross-Functional Expertise

Effective due diligence is achievable through collaboration among cross-functional teams.

Internal Team Structure (Example)

Role	Area of Responsibility	Key Deliverables
Deal Lead (Managing Director/Principal)	, IC Communication	DD Summary, Go/No-Go Recommendation
Financial Analyst (Associate/Vice President)	Financial Model, EBITDA Adjustment	Quality of Earnings Report
Legal Counsel (In-house/External)	Contract Review, Regulatory Review	List of Legal Issues
Operations Specialist	Operational Efficiency, Supply Chain Evaluation	Operational Assessment
Industry Expert	, Commercial Due Diligence Market Analysis	Market Study

Utilizing external advisors

Advisor Type	Responsible Area	Cost Level (Estimated based on mid-sized deal size)
Big Four accounting firms	Financial Due Diligence, Tax Due Diligence	$200K – $500K
Large law firm	Legal Due Diligence, Transaction Document	$300K – $800K
Strategy Consulting (McKinsey)	Commercial Due Diligence	$300K – $600K
Technology Consulting (EY-Parthenon, etc.)	Technology DD	$150K – $300K
ESG specialized institution	Environmental Due Diligence	$50K – $150K

1.4) Due Diligence Timeline: 4-8 weeks optimal range

Based on personal experience, there exists an optimal timeframe for completing a transaction.Both cases—excessively fast (leading to post-closing surprises due to inadequate due diligence) and excessively slow (resulting in loss of deal momentum or changes in market conditions)—negatively impact M&A outcomes.

General Timeline (Executed over a 4-6 week schedule)

Parking	Activity	Output
Week 1	Data Room Access, Initial Document Review, Issue List Preparation	Initial Request List, Key Focus Areas
Week 2	Management Presentation, Q&A Session, Site Visit	Management Meeting Notes, Site Visit Report
Week 3	In-depth Analysis, Expert Calls, Request Additional Materials	Draft DD Reports (by area)
Week 4	Gap Analysis, Final Questions, Issue Summary	Consolidated DD Summary
Weeks 5-6	Red Flag Consultation, Price Adjustment Negotiation, Final Report	Final DD Report, IC Memo

Critical Path Management

The bottleneck in due diligence typically arises fromdelays in data provision by the sellerorscheduling conflictsformanagement interviews. To prevent this,

1. Day 1 Request List:Immediately provide a standardized list of materials requested at the beginning of the transaction.
2. Weekly Progress Call:Weekly progress review with the seller's advisor
3. Escalation Protocol:Direct Communication Between Deal Leads When Data Provision is Delayed

---

II. Financial Due Diligence: Dissecting EBITDA

2.1) Core Purpose of Financial Due Diligence

Financial Due Diligence (FDD) is the processof verifying whether a target company's past financial performance reflects sustainable earnings power.
The key is to normalize Reported EBITDAto Adjusted EBITDAto derive true operating profitability.⁶

• The three major goals of FDD are:
  • Quality of Earnings (QoE) Verification:Ensuring reported earnings are repeatable and sustainable
  • Working Capital Analysis:Determining the Level of Working Capital Required for Normal Business Operations

2.2) EBITDA Adjustment: Normalizing Earnings

Reported EBITDA is merely a figure prepared according to accounting standards and is unsuitable for direct use in M&A valuation.
EBITDA Adjustment derives Sustainable EBITDAby eliminating one-time items, non-operating items, and abnormal costs/revenues.

Two Types of EBITDA Adjustments

Type	Explanation	Example
Pro Forma Adjustment	Adjustments affecting future outlook	Excluding revenue from customers whose contracts have ended, reflecting new costs, etc.
Normalizing Adjustment	Remove one-time/non-recurring items	Restructuring costs, litigation settlement payments, asset sale gains, etc.

Common EBITDA Adjustment Items (Example – Mid-sized Manufacturing Company ABC)

Adjustment items	Adjustment Direction	Impact (%p)
Non-Recurring Costs	+ (EBITDA increase)
– Restructuring/Workforce Reduction Costs	+	+2-5%
– M&A-related advisory fees	+	+0.5–2%
– One-time legal/litigation costs	+	volatile
– COVID-19-related expenses	+	+1-3%
Non-Recurring Revenue	– (EBITDA decrease)
– Gain on asset sale	–	-1 to -5%
– Receipt of insurance proceeds	–	volatile
– Government subsidy (one-time)	–	-1 to -3%
Owner-Related Costs	±
– Excessive owner compensation	+	+3-10%
– Personal vehicle, travel expenses	+	+0.5–2%
– Related-party transactions (compared to market price)	±	volatile
Accounting Policy Adjustment	±
– Timing differences in revenue recognition	±	volatile
– Differences in inventory valuation methods	±	volatile

FDD In-House Implementation Results (Practical Case Study) – Mid-Sized Manufacturing Company ABC Case Study

Item	Amount ($M)	Explanation
Reported EBITDA (Last Twelve Months)	25.0	Audit Report Standard
(+) CEO excessive compensation	1.2	$1.2M over the market price
(+) One-time restructuring costs	2.3	2024 Plant Consolidation
(+) M&A advisory fees	0.8	Regarding the previously failed transaction
(-) PPP loan forgiveness benefit	(1.5)	COVID-related one-time
(-) Insurance settlement amount	(0.6)	Fire compensation
(+) Reflecting normal rent	0.5	Adjustment of Market Value for Affiliated Company Buildings
Adjusted EBITDA	27.7	+10.8% increase

In this case, Adjusted EBITDA was calculated 10.8% higher than Reported EBITDA.
Applying an EV/EBITDA multiple of 8.0x, this translates to a value difference of approximately $21.6M in Enterprise Value terms (= $2.7M × 8.0x).

2.3) In-Depth Analysis of Quality of Earnings (QoE)

Quality of Earnings analysis goes beyond EBITDA adjustments to assess the sustainability and predictability of earnings.

• Key Questions for QoE Analysis
  1. Recurring Revenue:What percentage of sales is recurring revenue?
  2. Margin Stability:Has the EBITDA Margin been consistently maintained over the past three years?
  3. Quality of Growth:Is revenue growth driven by acquiring new customers or by additional purchases from existing customers?
  4. Cash Conversion Ratio:What is the conversion ratio of Operating Cash Flow relative to EBITDA?

Cash Conversion Analysis – Based on Mid-Sized Manufacturer ABC

Indicator	Calculation	Benchmark
Cash Conversion	Operating Cash Flow / EBITDA	80% (Good)
Free Cash Flow Conversion	Free Cash Flow / EBITDA	60% (Good)
Working Capital Days	(Accounts Receivable Days + Inventory Days) – Accounts Payable Days	Varies by industry

Red Flag – Signs to Watch for in QoE Analysis

• EBITDA increases but Operating Cash Flow decreases → Potential for worsening working capital or accounting manipulation
• Sales concentrated at year-end → Suspected channel stuffing (excessive inventory pushing)
• Rapid increase in related-party transaction volume → Potential for abnormal transactions relative to market price
• Accounts receivable turnover days sharply increased → Collection quality deteriorated

2.4) Working Capital Analysis: Setting the Net Working Capital Target

Working Capitalis a key variable in price adjustmentsduring M&A transactions. Sellers aim to minimize Working Capital before the transaction to extract cash, while buyers want a normal level of Working Capital maintained at the acquisition point.

• Net Working Capital (NWC) Definition
  • NWC = Current Assets (Operating) – Current Liabilities (Operating)

Items typically included in the NWC

• Includes:Accounts receivable, inventory assets, prepaid expenses, accounts payable, accrued expenses, advance payments
• Exclusions:Cash, short-term borrowings, current income tax liabilities (these are Net Debt or separate adjustment items)

NWC Target Setting Method (Draft)

Method	Explanation	Applicable situations
Trailing Average	Average NWC per month over the last 12 months	Business with low seasonality
Seasonal Adjustment	Comparing the same point in time while accounting for seasonal variations	Retail, agriculture, and other seasonal businesses
Peg Method	Fixed based on the NWC at a specific point in time	When preferring simplification

Working Capital Bridge Implementation (Example – Mid-sized Manufacturing Company ABC)

Item	Signing ($M)	Target ($M)	Difference
Accounts receivable	15.0	14.0	+1.0
Inventory assets	8.0	9.0	(1.0)
Advance expenses	1.5	1.5	0.0
Accounts Payable	(10.0)	(9.5)	(0.5)
Accrued expenses	(4.0)	(4.0)	0.0
Net Working Capital	10.5	11.0	(0.5)

In this case, since the Net Working Capital (NWC) at closing ($10.5M) fell short of the Target ($11.0M) by $0.5M, the buyer, Company S, deducted $0.5M from the Purchase Price.

2.5) Net Debt Analysis: The True Scope of Debt

Net Debt is not simply "borrowings minus cash."From an M&A perspective,Net Debt is broadly defined to includeDebt-Like Items.

Net Debt Components ( Example – Mid-sized Manufacturing Company ABC)

Item	Inclusion status	Explanation
Bank loans	✓	Including both short-term and long-term
Corporate bonds, Convertible bonds	✓	Face value or fair value
Financial lease liabilities	✓	After applying IFRS 16, all are recognized as liabilities.
Cash and cash equivalents	(-)	Deduction items
Debt-Like Items:
– Accrued Bonus	✓	When payment is scheduled prior to transaction completion
– Seller’s Transaction Costs	✓	Seller-borne advisory fees, etc.
– Litigation reserve	✓	Lawsuit with a high likelihood of losing
– Unfunded pension liabilities	✓	Underfunded Pension
– Environmental Restoration Reserve	✓	Contaminated Site Remediation Costs

---

III. Commercial Due Diligence: Verification of Market Hypotheses

3.1) Purpose and Scope of Commercial Due Diligence

Commercial Due Diligence (CDD)evaluates the attractiveness of the target company's market, its competitive position,andthe sustainability of its growth. While Financial DD verifies "past numbers," Commercial DDverifies "the future story."

• Core Questions of CDD
  1. Market Attractiveness:What is the TAM (Total Addressable Market), and what is the CAGR (Compound Annual Growth Rate)?
  2. Competitive Position:What is the target's market share? Sustainability of Competitive Advantage: How sustainable is the competitive advantage?
  3. Customer Quality:Are customer focus, churn rate, and LTV (Lifetime Value) at an appropriate level?
  4. Growth Realism:How feasible is the growth plan presented by Management?

3.2) Market Analysis: TAM-SAM-SOM Framework

TAM (Total Addressable Market):The total market size that a given product/service can target.
SAM (Serviceable Available Market):The market that is actually accessible (limited by region or segment).
SOM (Serviceable Obtainable Market):The market share that can realistically be captured.

Practical Case Study – Market Analysis (B2B Software Company Perspective)

Market level	Scale	Basis
TAM	$50B	Global ERP Software Market (20XX)
SAM	$12B	Cloud ERP for Mid-Sized Companies in the United States
SOM	$600M	Assuming current market share of 5% is maintained

• Market Validation Method (Inside)
  1. Top-Down Analysis:Refer to industry reports (Gartner, IDC, Forrester, etc.)
  2. Bottom-Up Analysis:Target Customer Count × Average Contract Value × Penetration Rate
  3. Expert Calls:Industry Expert Interviews (Typically 5-10 people)
  4. Competitor Benchmarking:Comparison of Competitor Performance and Growth Rates

• Red Flagin the case of
  • When Management's TAM estimate is more than twice as large as that in third-party reports
  • When the market growth rate assumption significantly exceeds the past five-year CAGR
• 
  When Companies O and S discover the aforementioned red flags, their operational teams renegotiate deal terms or, depending on the situation, rescind the transaction entirely. However, most corporate organizations cannot easily take such actions (
  ) and can only respond to red flags after confirming decisions through higher reporting lines.

3.3) Customer Analysis: Engagement and Churn Rate

Customer concentration is a significant risk factor in M&A.
If top customers account for an excessive proportion of total revenue, business continuity is threatened should those customers depart.

Customer Focus Benchmark (Example - B2B Software Company Standard)

Indicator	Green	Yellow	Red
Top 1 Customer Revenue Share	< 10%	10-20%	> 20%
Top 5 Customer Revenue Share	< 30%	30-50%	> 50%
Top 10 Customer Revenue Share	< 50%	50-70%	> 70%

Customer Churn Rate Analysis (Example – Based on B2B Software Companies)

Indicator	Calculation	SaaS Benchmark
Gross Revenue Churn	Churn Revenue / Base ARR	< 10% (양호)
Net Revenue Retention (NRR)	(Final ARR – New) / Base ARR	100% (Excellent)
Logo Churn	Number of customers who left / Number of base customers	< 15% (양호)

Practical Example – Example: Cohort Analysis for a B2B Software Company

Cohort (Year of Enrollment)	Year 1	Year 2	Year 3	Year 4	NRR
2022	$10.0M	$9.5M	$9.2M	$9.0M	90%
2023	$15.0M	$14.5M	$14.8M	–	99%
2024	$20.0M	$21.0M	–	–	105%
2025	$25.0M	–	–	–	–

In this case, the Cohort's NRR (Net Revenue Retention) exceeds 100% after 2024, indicating that upsells to existing customers are offsetting churn.

3.4) Competitive Analysis: Practical Application of Porter’s Five Forces

Apply Porter’s Five Forces to M&A Commercial DDto analyze the factors determining industry profitability.

Competitive factors	Analytical Questions	Risk Level Assessment
Competition among existing competitors	Market Concentration (HHI), Price Competition Intensity	높음: HHI < 1,000
Threat of new entrants	Entry barriers (regulations, capital, brand)	High: Low entry barriers
Threat of Substitutes	Customer switching costs	High: Low switching costs
Supplier bargaining power	Concentration of Core Raw Material/Component Suppliers	High: Single source
Buyer bargaining power	Customer Focus, Product Standardization Level	High: High customer focus

---

IV. Legal Due Diligence: Identification of Legal Risks

4.1) Scope and Purpose of Legal Due Diligence

Legal Due Diligence is the processof reviewing a target company's legal structure, contractual relationships, litigation status, and regulatory compliance to identify legal risks. Issues discovered during Legal DD often actas deal breakersor are reflected inthe Representations and Warranties clause.

Seven Key Areas of Legal Due Diligence

Domain	Key Review Items	Potential Deal Breaker
1. Corporate Structure	Articles of Incorporation, Shareholder Register, Subsidiary Structure	Low
2. Material Contracts	Change of Control Clause in Major Contracts	midway
3. Litigation	Pending/Expected Litigation, Regulatory Investigations	High
4. IP/Technology	Patent, Trademark, and Trade Secret Protection	High (Tech Industry)
5. Employment	Labor disputes, non-compete agreements	midway
6. Regulatory Compliance	Permits, environmental regulations, data protection	High (Regulated Industry)
7. Real Estate	Real estate rights, environmental pollution	midway

4.2) Contract Review: Pitfalls of Change of Control Clauses

The Change of Control (CoC) clauseis the contractual provision that requires the most careful review in M&A transactions.
If this clause is triggered, the main contract may automatically terminate, or the counterparty may be granted the right to terminate.

CoC Clause Review Checklist

Contract Type	Review Points	Risk Level
Major Customer Contracts	CoC Contract Termination/Renegotiation Authority	High
Supplier Contract	CoC Price Adjustment or Termination Authority	midway
Loan Agreement	Acceleration Clause in CoC	High
License Agreement	CoC license termination or reauthorization required	High (Tech)
Lease Agreement	Whether Landlord Consent is Required for CoC	midway
Labor Union Agreement	Obligation to renegotiate during CoC	midway

Practical Example – Loan Agreement CoC Clause
“A Change of Control shall constitute an Event of Default, and upon such event, the entire outstanding principal and accrued interest shall become immediately due and payable.”

If such a clause exists, the obligation to repay the existing loan in full arises upon completion of the acquisition.
This significantly impacts the acquisition financing plan, making waiver negotiations prior to signing essential.

4.3) Litigation Risk: Quantification of Contingent Liabilities

Pending litigation or anticipated legal disputes represent the most sensitive risks in M&A. During due diligence, litigation risks are quantified and reflected in purchase price adjustments or escrow arrangements.

Litigation Risk Classification

Risk Level	Criteria for Judgment	Reflection Method
Probable (High)	Probability of losing > 50%, amount estimable	Reflected as debt in Net Debt
Reasonably Possible (Moderate)	Probability of losing the case: 20-50%	Escrow Setup or Indemnity
Remote (Low)	패소 가능성 < 20%	Covered by the R&W clause

Practical Example – Quantifying Litigation Risk (Draft)

Types of Litigation	Claim Amount	Probability of losing	Expected loss	Reflection Method
Product Liability Lawsuit	$5M	60%	$3M	Reflecting Net Debt
Patent infringement lawsuit	$10M	30%	$3M	Escrow Setup
Labor dispute	$1M	70%	$0.7M	Reflecting Net Debt
Total estimated contingent liabilities			$6.7M

4.4) Deal Breaker Types and Counterstrategies

Deal breakers identified in legal due diligencecan be broadly categorized into three types.

• Type 1: Absolute Deal Breaker
  
  • Transactions subject to OFAC (Office of Foreign Assets Control) sanctions
  • Detection of false disclosures/accounting fraud
  • Scheduled revocation of core licenses/permits
  • Unresolvable large-scale lawsuits (e.g., class action lawsuits)

• Type 2: Conditional Deal Breaker (Negotiable)
  
  • CoC clauses in major customer contracts → Pre-negotiated waiver
  • Uncertainty regarding regulatory approval → Regulatory Approval Condition set
  • Environmental Contamination Liability → Seller Indemnity or Escrow

• Type 3: Reasons for Price Adjustment
  
  • Higher-than-expected litigation reserve
  • Unpaid taxes/penalties discovered
  • Working Capital Shortage

---

V. Operational Due Diligence: Hidden Value and Risks

5.1 Purpose of Operational DD

Operational Due Diligence (ODD)evaluates the target company's operational efficiency, process maturity, and infrastructure condition to identify post-closing value creation opportunities and operational risks. For private equity funds in particular, ODD servesas foundational data for establishing the 100-Day Plan, extending beyond mere risk identification.

Core Assessment Areas for ODD (Draft)

Domain	Evaluation Criteria	Value Creation Opportunities
Operational Efficiency	Operating rate, defect rate, lead time	Lean Manufacturing, Automation
Supply chain	Supplier Dependency, Inventory Management	Sourcing Optimization, Inventory Reduction
IT infrastructure	System obsolescence, security status	Digital Transformation, Cloud Migration
Organizational Structure	Decision-making speed, capability gap	Organizational redesign, talent acquisition
Customer Service	NPS, Response Time, Resolution Rate	CX Improvement, Automation

5.2 Manufacturing Operations Assessment: The Core of Site Visits

Site visits are the most critical activity in ODD. Theyallow us to directly observe operational realities that cannot be grasped through documentation alone and uncover hidden issues through dialogue with on-site management.

Site Visit Checklist (For Manufacturing)

Observation Area	Checkpoint	Red Flag Example
Facility Status	Cleanliness, safety signage, facility deterioration	Rusty equipment, faulty lighting
Work site	Worker Attitude, Compliance with Standard Operating Procedures	Congested pathways, failure to wear safety equipment
Inventory Management	Inventory stockpile status, FIFO compliance	Physical inventory, unclear labels
Quality Management	QC Process, Defect Tracking	Insufficient QC records, excessive rework
Maintenance	Preventive Maintenance Schedule, Parts Inventory	Excessive emergency repairs, parts shortage

5.3) IT/Technology Due Diligence: Digital Assets and Technical Debt

As of 2026,IT Due Diligence is no longer optional but essential. Cybersecurity risks and Data Compliance, in particular, have become significantly more critical.

Core Evaluation Areas for IT Due Diligence (Draft)

Domain	Evaluation Criteria	Risk Level
Infrastructure	Server Aging: Cloud vs. On-Premises	midway
Application	ERP, CRM modernization level, technical debt	midway
Data	Data Quality, Master Data Management	High
Cybersecurity	Penetration test results, security incident history	Very high
Data Privacy	GDPR, CCPA Compliance Status	Very high
AI Governance	Current Status of AI System Usage, Ethical Risks	High (New in 2026)

Key Cybersecurity Due Diligence Checklist

1. Security Incident History:Whether there have been any data breaches or ransomware attacks in the past three years
2. Vulnerability Scan:Results of external penetration tests conducted within the last six months
3. Certification Status:Possession of security certifications such as ISO 27001, SOC 2 Type II, etc.
4. Access Control:Privileged Account Management, MFA (Multi-Factor Authentication) Coverage
5. Data Encryption:Encryption Status of Stored Data (At Rest) and Transmitted Data (In Transit)
6. Backup and Recovery:Backup Frequency, Recovery Test Frequency, RTO/RPO Targets
7. Cyber Insurance:Coverage Scope and Limits

Alternatively, we assess through interviews whether candidates have experience or examples of hacking. This allows us to evaluate their practical cybersecurity capabilities in a paradoxical manner.

---

VI. HR & ESG Due Diligence: People and Sustainability

6.1) HR Due Diligence: Workforce Risk and Cultural Fit

One of the primary causes of M&A failure is "people" issues. HR Due Diligence evaluates workforce composition, labor dispute risks, the likelihood of retaining key talent, and cultural fit.

Core Areas of HR DD (Draft)

Domain	Evaluation Criteria	Potential Deal Breaker
Workforce Composition	Number of employees, occupational distribution, regional status	Low
Compensation System	Salary level, incentive structure, unpaid bonuses	midway
Employee Benefits	Unfunded pension liabilities, health insurance costs	High
Labor dispute	Union status, ongoing disputes, past strikes	High
Core Talent	Key Person Dependency, Non-Compete Agreement	High
Cultural Suitability	Organizational culture, value alignment	High (PMI Success Perspective)

Key Person Risk Analysis ( Example – B2B Software Company)

Person	Role	Substitutability	Non-competitive contract	Retention Plan
CEO	Strategy, Customer Relations	Low	2년	Earnout Arrangement
Chief Technology Officer	Technology Vision, R&D Lead	midway	1년	Stock option
Vice President of Sales	Key Account Manager	midway	None	Need
Chief Financial Officer	Finance, Investor Relations	High	1년	Unnecessary

The "Honeymoon Hangover Effect" refers tothe phenomenon where positive expectations (Honeymoon) are high during the initial M&A phase, but employee satisfaction plummets (Hangover) due to cultural clashes during the integration process.
To prevent this, diagnosing cultural gaps during the HR due diligence (DD) phase is necessary. Based on personal experience, Companies O and S each developed integration and absorption plans using different approaches.

6.2) ESG Due Diligence: Sustainability Risk

As of 2026,ESG (Environmental, Social, Governance) due diligencehas becomean essential element of large-scale transactions.
Particularly when entering the European market or acquiring listed companies, ESG risks can act as deal breakers.

Three Key Areas of ESG Due Diligence (Draft)

Domain	Evaluation Criteria	Financial impact
Environmental	Carbon emissions, environmental compliance, pollution liability	Environmental restoration costs, carbon tax
Social	Labor practices, industrial safety, supply chain human rights	Reputation risk, litigation costs
Governance	Board Composition, Internal Controls, Anti-Corruption	Regulatory sanctions, fines

Environmental Due Diligence – Environmental Responsibility Assessment (Draft)

Checkpoint	Red Flag	Latent costs
Contaminated Site History	Contamination of former factory site	$1M – $50M+
Waste Disposal	History of illegal waste disposal	Fines + Cleanup Costs
Climate Risk	Carbon-intensive business model	Carbon tax, stranded assets
Regulatory compliance	Violation of environmental permits	Business interruption risk

---

VII. Utilizing Due Diligence Findings: Negotiation and Decision-Making

7.1) Due Diligence Summary: IC Memo Preparation

The due diligence results are compiledinto a comprehensive report submitted to the Investment Committee (IC)and serve as the core basis for investment decisions.

IC Memo Due Diligence Section Structure (Draft)

Section	Content	Quantity
1. DD Executive Summary	Summary of Key Findings, Go/No-Go Recommendation	Page 1
2. Financial Due Diligence Findings	EBITDA Adjustment, Working Capital, Net Debt	Pages 2-3
3. Commercial Due Diligence Findings	Market validation, customer analysis, competitive positioning	Pages 2-3
4. Legal Due Diligence Findings	Key Legal Risks, Presence of Deal Breakers	Pages 1-2
5. Operational Due Diligence Findings	Operational risk, value creation opportunities	Pages 1-2
6. HR/ESG Due Diligence Findings	Workforce risk, ESG issues	Page 1
7. Risk Matrix & Mitigants	Risk Classification, Response Measures	Page 1

7.2) Price Adjustment Negotiations: Utilizing DD Findings

Issues identified during due diligence serve as key leverage points in price negotiations. The buyer quantifies the identified risks and requests an adjustment to the purchase price.

Framework for Presenting Price Adjustment Factors (Draft)

DD Findings	Impact	Adjustment Method
EBITDA downward revision	Direct impact on valuation	Purchase Price Recalculation
Working Capital Shortage	Additional acquisition funding required	Closing Adjustment
Contingent liability discovery	Future cost occurrence	Reflected in Net Debt or Escrow
Key Contract Risks	Sales uncertainty	Introduction of an Earnout Structure
Environmental Responsibility	Recovery costs	Seller Indemnity

Utilizing Earnout Structures (Example – B2B Software Company)

When there is a significant gap between management's growth projections and the buyer's conservative estimates, an earnout (conditional payment)is utilized to share the risk.

Earnout conditions	Period	Target Metric	Payment Amount
Year 1 Sales Target Achieved	12 months	Revenue over $50M	$5M
Achieved Year 2 EBITDA Target	24 months	EBITDA over $15 million	$7M
Year 3 Customer Retention Rate	36 months	NRR 100% or higher	$3M
Total Earnout Amount			$15M

7.3) Go/No-Go Decision-Making Framework

After completing due diligence, the final investment decisionis made. To this end, a decision-making framework combining quantitative evaluation and qualitative judgment, as practically applied by Company O and Company S, is utilized.

Decision Matrix (Example – Based on B2B Software Companies)

Evaluation Area	Weight	Score (1-5)	Weighted score
Valuation Attractiveness	25%	4	1.00
Financial Quality (QoE)	20%	3	0.60
Market/Growth Outlook	20%	4	0.80
Legal risk	15%	4	0.60
Operational risk	10%	3	0.30
HR/Cultural Fit	10%	3	0.30
Total Score	100%		3.60

Looking at the above illustrative matrix, some companies may feel decision paralysis pressure—where actual practitioners or middle managers (including executives) must logically and scientifically determine why each item's weight or score is set at 10% or 15%, demanding flawless reasoning.
This often leads to frontline staff wasting time and resources on trivialities instead of focusing on what truly matters.
Frankly speaking, based on my subjective experience, such organizations are typically companies or teams that face significant hurdles and obstacles from the very start of the deal process. In other words, directly sourcing and closing deals will never be easy within such organizations.

Proposed Decision Criteria Based on the Above Matrix

Total Score	Recommendation
> 4.0	Strong Go – Proactive Promotion
3.5 – 4.0	Conditional Go – Conditional Implementation (Price Adjustment Required)
3.0 – 3.5	Review Required – Decision pending additional review
< 3.0	No-Go – Recommendation to abandon the transaction

---

Conclusion: Due Diligence is an essential requirement for investment success.

Due Diligenceis a critical stepin M&A transactionsto resolve information asymmetry, manage investment risks, and secure negotiation leverage.
To summarize the above points into a framework, the following key principles were emphasized:

1. Prioritization of Scope
   • Reviewing all areas with the same depth is inefficient.
   • Select focus areas using a Risk-Based Approach according to the nature of the deal and industry characteristics.
     
2. Normalization of Numbers
   • Reported EBITDA cannot be used as is.
   • Derive sustainable profitability through EBITDA adjustments and reflect this in valuation
     
3. Verification of the Market Hypothesis
   • Management's growth story cannot be accepted as is.
   • Independently verified from market, customer, and competitive perspectives through commercial due diligence
     
4. Early Identification of Deal Breakers
   • Legal/regulatory risks determine the success or failure of a deal.
   • Identify absolute deal breakers early in legal due diligence to prevent wasting time and resources
     
5. Recognition of the Importance of People
   • A significant portion of M&A failures stem from personnel/cultural issues.
   • Develop a core talent retention plan through HR DD and prepare an integration strategy for cultural gaps.
     
6. Strategic Utilization of Results
   • Due diligence is not about completing a checklist.
   • Strategically leverage identified issues in price negotiations, contract term design, and post-closing value creation plans

The next "Part 4 Content" will coverDeal Structure & Negotiation Strategy.
We plan to cover the differences between Stock Deals and Asset Deals, the design of Earnouts and Escrow, and negotiation strategies for Representations and Warranties (R&W) and Indemnity clauses, using specific examples and past experiences.

---

Endnotes

1. https://www.emerald.com/jdqs/article-pdf/28/3/123/1390833/jdqs-06-2020-0014.pdf
   https://sajbm.org/index.php/sajbm/article/download/692/624
   https://www.mdpi.com/2071-1050/12/7/2999/pdf ↩︎
2. https://www.stout.com/en/insights/article/due-diligence-deal-maker-or-breaker ↩︎
3. https://mnainstitute.com/financial-due-diligence-report ↩︎
4. https://www.researchoptimus.com/blog/dodging-deal-breakers-through-comprehensive-ma-due-diligence/ ↩︎
5. https://farrellymitchell.com/due-diligence-consulting/operational-due-diligence/
   https://greenwichcapital.com.au/insights/ultimate-guide-to-due-diligence/ ↩︎
6. https://mnainstitute.com/financial-due-diligence-report/
   https://www.freedmaxick.com/insights/common-normalizing-adjustments-financial-due-diligence-freed-maxick ↩︎