M&A Due Diligence Priorities

Step 1: Weighted Red Flag Score

Weighted Red Flag Score = Σ (Workstream Weight × Severity Rating)

Plugging in each workstream's weight and severity rating:

Weighted Red Flag Score = 1.20 + 0.60 + 0.60 + 0.30 + 0.30 + 0.10 = 3.10

This weighting exists because not every red flag threatens the deal equally: a financial-reporting irregularity calls into question the numbers the entire valuation is built on, so it carries more weight than an HR gap that a post-close employment agreement can fix in week one. Interviewers use a case like this to test whether a candidate treats due diligence as a checklist or as a risk-prioritization exercise.

Step 2: Go/No-Go Recommendation

Decision = "Proceed" if Score < 2.5; "Proceed with Price/Terms Adjustment" if 2.5 ≤ Score < 3.5; "Escalate to IC / Walk Away" if Score ≥ 3.5

With a weighted score of 3.10, the deal falls in the middle band:

3.10 is between 2.5 and 3.5 → Proceed with Price/Terms Adjustment

A score in this band tells the deal team the target is fundamentally acquirable, but the buyer shouldn't sign at the originally discussed price and terms. In practice this translates into specific asks: a purchase price reduction or earnout tied to resolving the revenue recognition issue, a customer-concentration indemnity, and a tax escrow sized to the unfiled-returns exposure. None of the individual findings is severe enough on its own (no rating of 5) to justify walking away, which is exactly why a single weighted score is more useful to the investment committee than a long list of unranked findings.

Final Results

• Weighted Red Flag Score: 3.10
• Recommendation: Proceed with Price/Terms Adjustment

This score becomes the anchor for the purchase agreement negotiation — the specific findings behind it map directly onto the reps & warranties, indemnification caps, and any escrow or earnout structure the buyer's counsel drafts next.

Would you like to explore how the buyer would size a specific indemnity escrow against the tax and legal findings above?