You’ve built a profitable £10M business. Private equity interest is starting to knock. Your accountant says your books are “clean.” Then due diligence begins, and everything falls apart.
This scenario plays out more often than you’d think. Because there’s a world of difference between books that satisfy HMRC and books that satisfy private equity investors conducting forensic due diligence.
We’ve sat on both sides of these deals – as auditors at Big 4 scrutinising targets, and now helping mid-market businesses prepare for investor scrutiny. The gap between “compliant” and “investable” is wider than most business owners realise, and it takes 6-12 months to bridge properly, not the 6 weeks most people assume.
Why PE Investors Scrutinise Differently Than HMRC
Your current accountant has likely optimised your books for one thing: minimising tax liability whilst staying compliant. That’s their job, and it’s important.
But private equity investors have completely different priorities. They’re not asking “Did you follow the rules?” They’re asking:
- Can we trust these numbers to make a £20M investment decision?
- Will these financials hold up under bank financing scrutiny?
- Are there any hidden liabilities or compliance issues that could blow up post-acquisition?
- Can we clearly explain this business model and its financials to our limited partners?
- Is the EBITDA real, or is it window dressing?
When PE firms bring in forensic accountants from Big 4 firms for due diligence (and they always do), those teams are trained to find problems. Their entire engagement is premised on scepticism. They’re not there to validate your story – they’re there to stress-test it until something breaks.
The Green Flags: What Makes Investors Confident
Clean Revenue Recognition
Private equity investors want to see revenue that follows a clear, defensible pattern. This means consistent policies around when revenue is recognised, how contracts are structured, and how you handle deposits, milestones, and recurring revenue.
If you’re recognising revenue on percentage-of-completion for long-term projects, you need documentation that proves your milestone tracking is rigorous. If you’ve got subscription revenue, your deferred revenue schedules need to reconcile perfectly. Any inconsistency in how revenue is recognised across similar transactions raises immediate red flags.
Predictable Gross Margins
Gross margins that fluctuate wildly month-to-month or year-to-year suggest you don’t have control over your cost base or pricing. Investors expect to see margins that track to a clear story: seasonal variations you can explain, pricing changes you can document, or cost initiatives you can demonstrate.
If your gross margin was 45% two years ago, 38% last year, and 52% this year, you’d better have a compelling narrative backed by data. Otherwise, it looks like your accounting is unreliable or your business is unpredictable – neither of which inspires confidence in a seven-figure cheque.
Manageable Customer Concentration
Most investors want to see no single customer representing more than 20% of revenue, and ideally no single customer over 10%. If you’ve got customer concentration above these levels, it’s not necessarily a deal-breaker, but it will materially impact valuation.
The due diligence team will want to see contracts, payment histories, and evidence of relationship stability for your major customers. They’ll also want comfort that there are no informal arrangements, personal relationships, or handshake deals keeping these customers loyal – because those don’t transfer with ownership.
Working Capital Management
Your working capital cycle tells investors whether you’ve built a cash-generative business or one that requires constant funding to grow. They’ll analyse your debtor days, creditor days, and inventory turnover with forensic detail.
If your debtors are stretching from 30 days to 60 days to 90 days, that’s a problem. If you’re constantly chasing cash to meet payroll, that’s a problem. If your stock levels are ballooning without corresponding revenue growth, that’s a problem.
Investors want to see disciplined working capital management with clear policies and consistent execution.
Real EBITDA (Not Creative Accounting)
This is where most deals hit trouble. Your accountant may have calculated EBITDA one way, but PE investors will recalculate it their way and the gap can be shocking.
They’ll add back owner salary above market rate (but not the full amount you’re paying yourself). They’ll add back genuine one-off costs (but not the “one-off” costs that happen every year). They’ll normalise rent if you’re paying above or below market rates. They’ll scrutinise every add-back you’ve claimed and challenge half of them.
If your EBITDA is £2M on paper but only £1.4M after investor adjustments, your valuation just dropped by 30%. And if you’ve built your expectations around the higher number, the deal psychology shifts dramatically.
The Red Flags That Kill Deals
Unexplained Volatility
Revenue that jumps 40% one year then drops 25% the next, with no clear external drivers, suggests your numbers aren’t reliable. Either your accounting methods are inconsistent, or your business model is fundamentally unpredictable.
Investors can handle volatility if you can explain it with external factors: regulatory changes, market conditions, major contract wins or losses. What they can’t handle is volatility that suggests the numbers themselves aren’t trustworthy.
Related Party Transactions You Can’t Justify
Paying your spouse’s company £60,000 a year for “consulting services” with no documentation? Renting premises from a company you own at above-market rates? Buying supplies from your brother-in-law’s business without competitive quotes?
These arrangements might be perfectly legitimate, but if you can’t produce contracts, market comparisons, and clear business rationale, they’ll get stripped out of normalised EBITDA. Worse, they create a perception that the business has been run for personal benefit rather than commercial optimisation.
Tax Positions That Don’t Hold Up
Aggressive R&D tax credit claims, capital allowances that wouldn’t survive an HMRC enquiry, or VAT treatment that’s technically questionable – these all create problems in due diligence.
PE investors don’t want to inherit tax risks. If your tax returns show positions that a Big 4 tax team wouldn’t defend, those will either need to be corrected (often triggering tax bills and penalties) or will create indemnity issues that reduce your proceeds.
Documentation Chaos
Missing invoices, contracts filed inconsistently, supplier agreements that are verbal rather than written, employee contracts that don’t match payroll records – this kind of administrative sloppiness suggests operational risk.
If you can’t produce a clean audit trail for your top 20 customers and suppliers, due diligence will take twice as long and cost twice as much. Every missing document creates doubt about what else might be missing.
Personal Expenses in the Business
Your Tesla lease, your golf club membership, your family holiday classified as “business development” – these need to be identified and normalised out of EBITDA. If they’re buried throughout the accounts and difficult to separate, it suggests the boundary between business and personal has been blurred for years.
Investors need to see a business that can operate independently of your personal spending patterns. If the accounts don’t clearly separate these, it raises questions about what else might be hidden.
The Reality: Most SMEs Aren’t Ready
Here’s what typically happens: a business owner runs their company for years with a capable local accountant focused on tax efficiency and compliance. The books are “fine” – they pass audit if required, HMRC accepts them, the bank’s happy with them.
Then PE interest emerges, and suddenly those same books are being scrutinised by former Big 4 partners who’ve spent 20 years finding problems in financial statements. The gap between “compliant” and “investable” becomes painfully apparent.
Common issues we see in £5M-£20M businesses:
Revenue recognition that’s technically correct but inconsistently applied across similar transactions. Chart of accounts designed for tax reporting, not management information or investor presentation. Fixed assets that haven’t been properly tracked or depreciated. Provisions and accruals based on rough estimates rather than detailed calculations. Intercompany transactions (if you’ve got a group structure) that aren’t properly documented or priced.
None of these issues would typically cause HMRC problems. But they’ll cause PE investors serious concerns.
The Timeline: Why You Need 6-12 Months
If private equity interest is even remotely on your horizon, you need to start preparing now. Here’s why it takes so long:
Months 1-3: Diagnostic and Clean-up
A proper PE-readiness review will identify 20-40 issues across your financial statements, controls, and documentation. Some are quick fixes (missing invoices, unsigned contracts). Others require systems changes (revenue recognition policies, fixed asset registers). A few might require restating prior periods if the issues are material.
Months 4-6: Process Implementation
You need to implement proper month-end close processes, management accounts that tell a clear story, and documentation standards that will satisfy due diligence. This isn’t just about the numbers – it’s about creating an audit trail that demonstrates control and rigour.
Months 7-9: Testing and Refinement
The new processes need to run for at least two quarters before investors will trust them. You need to demonstrate that the improvements are sustainable, not just a one-off clean-up exercise. This period also allows you to build the narrative around your numbers – the story that explains your business model, margin drivers, and growth trajectory.
Months 10-12: Documentation and Positioning
Building the information memorandum, quality of earnings report, and supporting schedules that will form the basis of your data room. This documentation needs to pre-empt questions, address weaknesses proactively, and present your business in the best possible light whilst remaining scrupulously accurate.
You cannot compress this timeline. Attempts to do so invariably lead to either failed deals or significant valuation haircuts when problems emerge in due diligence.
How to Prepare Your Books for PE Scrutiny
Get a Pre-Due Diligence Review
Before you engage with investors, commission your own due diligence review from advisers who’ve worked on PE deals. This will cost £10,000-£25,000 depending on complexity, but it’s the best money you’ll spend. You’ll get a clear list of issues to address and can fix them on your timeline rather than under deal pressure.
Implement Robust Month-End Close
Your monthly management accounts should be completed within 10 working days of month-end, with supporting schedules, variance analysis, and clear audit trails. If you’re currently taking 30+ days to close the books, that’s a red flag that you don’t have proper controls.
Document Everything
Every significant accounting judgement, policy decision, or estimate should be documented in writing. Why did you capitalise that software development cost? How did you calculate that provision? What’s the basis for that debtor write-off? If you can’t produce a written rationale, it looks arbitrary.
Separate Business and Personal
Remove all personal expenses from the business and document any related party transactions with proper commercial terms. If you’re paying yourself £200,000 but market rate for your role is £120,000, that’s fine – but it needs to be clearly identified as an add-back.
Build Your Data Room Early
Start collecting the documents that will inevitably be requested: supplier contracts, customer agreements, employee contracts, insurance policies, property leases, intellectual property registrations, regulatory licences, and historical financial statements. Organise them logically and ensure they’re all current.
The Bottom Line
Private equity investors are not buying your business based on trust. They’re buying based on verifiable financial performance demonstrated through rigorous documentation and defensible accounting.
The gap between HMRC-compliant books and investor-ready books is significant. The businesses that successfully navigate PE transactions are those that start preparing 12 months before they need to, not 12 weeks.
If PE interest is on your horizon or even a remote possibility, your books need to tell a clean, consistent, defensible story. Because when forensic accountants start digging, it’s too late to rewrite the narrative.
Need to Get PE-Ready?
At FMY Chartered Accountants, we’ve been on both sides of these transactions. We know what PE investors look for because we’ve conducted the due diligence that makes or breaks deals.
We work with ambitious £2M-£50M businesses to bridge the gap between compliance and investment readiness – with Big 4 expertise at mid-market pricing.
Book a free PE-readiness consultation: https://calendly.com/fmy-chartered-accountants/45min
Email: info@fmyaccountants.co.uk