What Is Due Diligence? | Agency M&A Definition
Due diligence is the formal investigation process a buyer conducts after signing a Letter of Intent to verify all material facts about the target agency. It covers financials, legal obligations, client contracts, employee arrangements, and operational systems. The findings either confirm the deal terms, lead to renegotiation, or in some cases, kill the transaction entirely.
Due Diligence in Agency M&A
Due diligence in agency M&A is uniquely challenging because so much of an agency’s value lives in intangible assets — client relationships, team talent, institutional knowledge, and brand reputation. Unlike acquiring a software company where you can audit code and subscription metrics, buying a marketing agency requires evaluating the stickiness of human relationships and the sustainability of creative output.
Buyers evaluating a creative agency typically focus on five areas during diligence: financial verification (are the reported numbers accurate and recurring?), client analysis (how concentrated is revenue and what do contracts actually guarantee?), talent assessment (will key staff stay post-acquisition?), legal review (are there any pending disputes, IP issues, or problematic contract terms?), and operational infrastructure (are there systems that run without the founder?). For agencies in the $1M-$5M revenue range, the diligence process typically takes 30-60 days and involves sharing access to accounting software, CRM data, project management tools, HR records, and client agreements. Sellers should prepare a data room well before going to market — agencies that can produce organized documentation quickly signal professionalism and reduce buyer anxiety.
How Due Diligence Affects Agency Valuation
Due diligence findings routinely adjust deal valuations by 10-25%. Common discoveries that reduce price include understated contractor costs that inflate margins, verbal client agreements with no contractual protection, key person dependencies not disclosed during negotiations, and pending or threatened legal claims. On the flip side, thorough diligence occasionally reveals upside — untapped service lines, underpriced contracts ready for renewal, or stronger-than-expected client lifetime values — though this is less common. Buyers often use a quality of earnings analysis during diligence, which can reclassify one-time revenues as non-recurring, effectively reducing EBITDA and compressing the deal value.
Example
A buyer agrees to acquire a paid media agency for $2.8M based on $560K adjusted EBITDA (5x multiple). During due diligence, the buyer discovers that $85K of reported revenue came from a one-time project that will not recur, and $40K in contractor costs were misclassified as a capital expense. Adjusted EBITDA drops to $435K. The buyer renegotiates the price to $2.175M (5x the revised EBITDA), a $625K reduction. The seller, having already signed an exclusivity agreement, accepts $2.3M after further negotiation — still $500K less than the original LOI.
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