Unlike standard M&A due diligence, FDD in a restructuring context is conducted under more time pressure, with higher levels of uncertainty and complexity. Historical performance is often less reliable as a predictor of future results, requiring deeper scenario analysis, stress testing, and sensitivity modelling. For creditors, investors, and management teams, the goal is to establish a realistic view of financial viability and the sustainability of the proposed changes. This process also ensures that capital is allocated effectively and in line with risk appetite.
In cases of company restructuring, due diligence plays a dual role: validating the assumptions of the restructuring plan and ensuring that the capital structure, liquidity profile, and operational improvements align with long-term strategic objectives. This is especially important when the restructuring involves debt-to-equity swaps, carve-outs, or asset divestitures, where financial interdependencies must be clearly understood. Investors must assess not only the numbers on paper but also the operational levers that can deliver those numbers in reality. Failure to do so risks overestimating the upside or underestimating the financial and operational hurdles ahead.
Key Objectives of Financial Due Diligence in Restructuring
The FDD process in restructuring has several objectives, including:
- Assessing Liquidity and Cash Flow Stability – Ensuring the business can meet its short-term obligations and fund restructuring-related expenses.
- Validating Forecasts – Stress-testing management’s projections under multiple scenarios to determine whether they are realistic.
- Identifying Hidden Liabilities – Detecting off-balance-sheet obligations, contingent liabilities, or pending legal claims that may affect value.
- Understanding Debt Structure – Analyzing the cost, maturity, and covenants of existing debt to inform refinancing or renegotiation strategies.
- Evaluating Working Capital Efficiency – Reviewing inventory turnover, receivables, and payables to identify potential cash release opportunities.
By addressing these areas, stakeholders can make more informed, risk-adjusted investment decisions.
Key Components of the Process
- Historical Financial Analysis – Even if the business is distressed, reviewing three to five years of financial statements helps identify trends, cyclical patterns, and anomalies.
- Quality of Earnings (QoE) Assessment – Adjusting earnings for non-recurring items, extraordinary expenses, or accounting irregularities to arrive at a normalized profitability figure.
- Cash Flow Forecast Validation – Comparing management’s cash flow forecasts with independent modelling to test assumptions and identify potential shortfalls.
- Capital Expenditure Review – Understanding future capex needs to sustain operations or execute the restructuring plan.
- Tax Review – Identifying tax liabilities, opportunities for optimization, and the impact of restructuring on tax positions.
The Role of Scenario Planning and Stress Testing
In restructuring contexts, financial due diligence is incomplete without robust scenario analysis. This involves modelling best-case, base-case, and worst-case outcomes to understand the financial resilience of the business under different economic and operational conditions. Stress testing can expose vulnerabilities in cash flow or debt service capacity, allowing stakeholders to prepare contingency plans or renegotiate deal terms before committing capital.
Collaboration Between Advisors and Management
FDD in restructuring works best when there is open collaboration between financial advisors, legal counsel, operational consultants, and the company’s management team. Management’s insight is crucial for understanding operational realities, while external advisors bring an independent perspective and technical expertise. Clear communication ensures that all stakeholders are working from the same data sets and financial assumptions, reducing the risk of misalignment during execution.
Common Pitfalls to Avoid
Even experienced investors can fall into traps during restructuring due diligence, such as:
- Relying Too Heavily on Management’s Projections – Without independent validation, these forecasts may be overly optimistic.
- Overlooking Non-Financial Risks – Operational bottlenecks, regulatory hurdles, and cultural resistance can undermine financial improvements.
- Ignoring Post-Restructuring Capital Needs – Many deals fail because insufficient working capital is available after restructuring to support growth.
- Underestimating Execution Risk – Even the most attractive plan on paper requires disciplined execution, which may be challenging in a turnaround environment.
Avoiding these pitfalls requires discipline, scepticism, and a commitment to fact-based decision-making.
Post-Investment Monitoring
Due diligence is not a one-time exercise. Once the restructuring investment is made, ongoing financial monitoring is essential to ensure that the plan stays on track. This includes monthly or quarterly performance reviews, variance analysis, and early-warning indicators for potential financial distress. Investors should also establish clear governance structures to maintain oversight and accountability.
Financial due diligence is the cornerstone of sound restructuring investment decisions. It goes beyond validating the financial health of a company—it provides the insight necessary to design viable capital structures, realistic operational improvements, and credible value creation plans. In the high-stakes environment of company restructuring, careful, methodical due diligence can mean the difference between a successful turnaround and a costly failure. By combining rigorous financial analysis with scenario planning, risk assessment, and collaborative execution, investors and stakeholders can navigate uncertainty with confidence and position themselves for sustainable returns.
Related Resources:
Asset Divestiture and Portfolio Restructuring for Value Creation
Human Resources Planning in Large-Scale Business Restructuring