How to Do Due Diligence on an Indian Business (Step-by-Step)

Due diligence is where most deals die — and where bad deals should die. In India, the process has unique challenges: informal accounting, cash transactions, complex compliance requirements, and varying documentation standards. This guide walks through exactly what to check, how to verify it, and what red flags should kill a deal.

What is Due Diligence and Why Does It Matter?

Due diligence is the process of verifying everything a seller claims before you buy their business. It covers financials, legal standing, operations, employees, customers, and liabilities. In India, due diligence matters more than in developed markets because documentation standards vary widely. Many small businesses operate partially in cash, maintain informal records, or have compliance gaps. Your job is to uncover reality versus what's presented. Skipping due diligence or doing it superficially is the single biggest mistake buyers make. A thorough process takes 2-6 weeks depending on business complexity. The cost of hiring professionals (₹50,000-2,00,000) is trivial compared to buying a lemon.

What Documents Should You Request First?

Start with these foundational documents before diving deeper. Request them immediately after signing an LOI (Letter of Intent) or MOU. First tier: last 3 years of ITR (Income Tax Returns), GST returns for 24 months, audited financial statements, bank statements for all business accounts (24 months), and PAN/TAN registration documents. Second tier: incorporation documents, shareholder agreements, board resolutions, all contracts and agreements, employee records, and property/lease documents. Don't proceed with detailed diligence until you have at least the first tier. Sellers who resist providing basic documents are hiding something.

How Do You Verify Financial Statements in India?

Indian small businesses often maintain multiple sets of books — one for taxes, one for internal use, one for banks. Your job is finding the real numbers. Start with bank statements — they don't lie. Calculate actual cash inflows and outflows. Compare against reported revenue in GST returns and ITR. Discrepancies are common; massive discrepancies are red flags. Check GST return data against sales invoices. Verify major expenses against actual payments. For businesses with significant cash transactions, accept that you'll never get 100% accuracy. Focus on understanding the range and adjusting your offer accordingly. Hire a CA experienced in transaction advisory — they know what to look for.

How Do You Check GST Compliance?

GST compliance issues can become your liability post-acquisition. Check the GST portal for the business's compliance status. Verify all returns have been filed on time. Look for any notices, demands, or pending assessments. Request copies of all GST returns (GSTR-1, GSTR-3B) for at least 24 months. Compare GSTR-1 (outward supplies) against actual sales records. Check input tax credit claims against purchase invoices. Verify that major vendors and customers are GST-compliant — their non-compliance can affect the business. Any GST litigation or pending demands should be resolved or escrowed before closing.

What Legal Checks Are Essential?

Legal due diligence in India covers registrations, licenses, litigation, and encumbrances. Essential checks include: Company/LLP registration status on MCA portal, trademark and IP registrations, all required business licenses (FSSAI, drug license, shop establishment, etc.), pending or historical litigation (search court records), property title verification if real estate is involved, and charge searches for any secured loans. Also verify the seller's authority to sell — check board resolutions, shareholder approvals, and any restrictions in shareholder agreements. Hidden litigation is common. Search the seller's name, directors' names, and business name across court databases.

How Do You Verify Employee Liabilities?

Employee liabilities can surprise buyers post-acquisition. Under Indian law, you may inherit certain obligations. Check PF (Provident Fund) compliance — verify registration, monthly deposits, and any pending dues. Same for ESI (Employee State Insurance) if applicable. Request employee lists with joining dates, salaries, and designations. Verify actual headcount against payroll records. Check for any pending labor disputes, union issues, or wrongful termination claims. Gratuity liability for employees with 5+ years must be calculated and either settled pre-closing or adjusted from purchase price. Get representations and warranties covering employee matters, with indemnification for undisclosed liabilities.

What Tax Issues Should You Check?

Beyond GST, verify income tax compliance thoroughly. Request ITRs for 3 years plus all assessment orders and notices. Check if any assessments are pending or under scrutiny. Verify TDS compliance — the company should have deposited all TDS on employee salaries, contractor payments, and rent. Outstanding tax demands should be resolved or escrowed. For asset deals, understand the tax implications carefully — capital gains for seller, depreciation benefits for buyer. For share deals, check the company's tax positions and any carried-forward losses. Engage a tax consultant to review positions and flag risks. Tax surprises post-acquisition are common and expensive.

How Do You Evaluate Customer Concentration Risk?

Customer concentration kills businesses. If one customer represents more than 20-25% of revenue, you're buying a dependency, not a business. Request customer-wise revenue breakdown for 3 years. Identify the top 10 customers and their revenue contribution. Understand the history — how long have they been customers? Are there contracts? What's the renewal pattern? If concentration exists, talk to major customers before closing. Understand their satisfaction, future plans, and relationship with the seller personally. High concentration isn't always a dealbreaker but should significantly affect valuation and deal structure. Consider earnouts tied to customer retention.

How Do You Verify Assets and Inventory?

Physical assets need physical verification. Don't trust depreciation schedules alone. Visit the business premises. Count and inspect machinery, equipment, vehicles, and furniture. Compare against the fixed asset register. Check condition, age, and functionality. For inventory, conduct a physical count or hire a third party. Compare against book value. Identify obsolete, slow-moving, or damaged inventory. Adjust valuation accordingly. For equipment, check ownership documents (invoices, import documents). Verify no assets are leased, rented, or encumbered. For vehicles, check RC books and insurance. Hidden liens on assets can transfer to you post-acquisition.

What Operational Due Diligence Should You Do?

Beyond numbers, understand how the business actually runs. Spend time at the premises. Observe operations. Talk to employees (with seller permission). Understand the seller's actual role — are they doing everything, or is there a team? Key questions: What happens if the seller leaves day one? Who holds customer relationships? Who knows how to run the machines? Where is institutional knowledge documented? Understand key vendor relationships. Are there any single-source dependencies? What are payment terms and history? Operational diligence reveals whether you're buying a business or buying a job.

How Do You Handle Undocumented Cash Transactions?

Many Indian small businesses have cash components that don't show in official records. This is reality. You need to make a judgment call. First, understand the extent. Sellers will often share "real" numbers verbally. Verify where possible — physical footfall, inventory turnover, utility bills, and employee testimony. Decide how much to trust. Discount undocumented revenue heavily in your valuation. If the seller claims ₹50 lakhs in cash revenue, maybe value it at ₹25-30 lakhs. You can't verify it, and you can't complain later if it doesn't exist. Never pay for unverifiable cash revenue at full value. Structure deals with earnouts tied to actual post-acquisition performance.

What Are the Biggest Red Flags in Due Diligence?

Some findings should kill deals immediately. Walk away if you find: Significant undisclosed litigation (especially tax or criminal matters), major discrepancies between bank statements and reported revenue (suggests fraud), pending statutory dues that exceed expectations (PF, ESI, TDS arrears), key customers already churning or planning to leave, seller unable to explain basic business operations, undisclosed related-party transactions that benefit the seller, clean-up of records right before sale (suggests manipulation), or seller resistance to reasonable diligence requests. Trust your instincts. If something feels wrong, it usually is.

Should You Hire Professionals for Due Diligence?

For any deal above ₹25-50 lakhs, professional help is worth the cost. At minimum, engage a CA for financial and tax diligence. Budget ₹30,000-75,000 depending on complexity. For legal diligence, engage a lawyer experienced in M&A. Budget ₹50,000-1,50,000. For larger deals or complex industries, consider specialized consultants (environmental, technical, HR). The cost of professionals (₹1-3 lakhs total) is insurance against buying hidden liabilities. One undiscovered tax demand or labor dispute can cost multiples of the diligence fee. Don't be penny-wise and pound-foolish.

How Long Should Due Diligence Take?

Standard due diligence takes 3-6 weeks for a typical small business. Factors that extend timelines: poor documentation (add 2-3 weeks for reconstruction), complex corporate structure, multiple locations, regulated industries, or overseas components. Don't let sellers rush you. Artificial urgency is a negotiating tactic. If they have other buyers, let them walk. A good deal will wait for proper diligence. Use the diligence period to also prepare for transition. Understand operations, build relationships, and plan your first 90 days. This parallel work maximizes the time investment.

What Happens After Due Diligence?

Due diligence findings inform three things: whether to proceed, at what price, and with what protections. If findings are clean, proceed at agreed price with standard warranties. If findings reveal issues, you have options: renegotiate price downward, require seller to fix issues pre-closing, escrow funds for potential liabilities, or strengthen indemnification provisions. If findings reveal dealbreakers, walk away. Don't fall in love with a deal. There are always more businesses. A clean walk-away is better than a messy acquisition. Document your diligence process — it protects you if disputes arise later about what was or wasn't disclosed.