Due Diligence in Life Sciences: What to Expect

For life sciences companies, due diligence represents far more than a routine checkbox in a transaction process. Whether you're raising venture capital, preparing for acquisition, or negotiating a strategic partnership, the scrutiny your company faces can determine not just deal terms—but whether the deal happens at all.

Regulatory complexity, lengthy development timelines, capital-intensive R&D programs, and intricate revenue structures create layers of risk that investors examine exhaustively. Understanding what to expect (and how to prepare) can mean the difference between a smooth transaction at favorable terms and a process that stalls, reprices, or collapses entirely.

The Due Diligence Landscape: A Multidisciplinary Exercise

In transactions involving life science companies, the due diligence process typically examines four interconnected dimensions:

Each of these dimensions is closely connected to the others, and issues in one area can have a cascading impact across the business. A regulatory warning letter doesn't just create compliance risk: it can delay product launches, affecting revenue projections and ultimately the company’s valuation.

Financial Due Diligence: Where Deals Are Won or Lost

In life sciences M&A, financial due diligence isn’t a box-checking exercise: it’s where valuation gaps are exposed, synergies are tested, and deal economics are ultimately decided. From revenue recognition under ASC 606 to R&D capitalization and clinical trial accounting, small missteps can translate into major valuation swings. Robust due diligence reveals the true economic engine of a business and determines whether a buyer is paying for growth or for accounting smoke and mirrors.

Quality of Earnings and Revenue Recognition

Quality of earnings analysis cuts through accounting presentations to reveal true economic performance of a business. Life sciences transactions consistently surface accounting issues during financial due diligence, most commonly around revenue recognition, R&D treatment, and clinical trial accruals.

The adjustments matter because they directly impact valuation. Consider these life sciences-specific questions acquirers scrutinize:

• • R&D treatment: Have you capitalized development costs that should be expensed? This inflates assets and earnings.
  • Grant revenue: Is government funding properly recognized as you meet performance obligations, or front-loaded?
  • Milestone payments: Are collaboration agreement milestones recognized appropriately under ASC 606?

Revenue recognition under ASC 606 creates particular complexity. Upfront licensing payments, milestone-based payments tied to clinical or regulatory achievements, and royalty structures all require defensible documentation. A medical device company, for instance, might receive a $10 million upfront payment for exclusive distribution rights, but if substantive performance obligations remain, recognizing the full amount immediately creates a quality of earnings issue that investors will adjust out.

Acquirers typically calculate "normalized" EBITDA by stripping out one-time items, aggressive accounting choices, and unsustainable practices. In life sciences transactions, normalized EBITDA can differ from reported EBITDA by a significant amount, often affecting deal value.

Clinical Trial Accounting and R&D Expenses

Clinical trial accounting represents one of the most problematic areas in life sciences due diligence. When a Phase II trial moves to Phase III, patient populations expand, site counts multiply, and monitoring intensity increases—often tripling quarterly burn. If your accruals don't reflect this transition, your runway calculation becomes fiction.

Common pitfalls that trigger valuation concerns:

• • Underaccrued expenses due to delayed vendor invoicing
  • Incomplete patient enrollment cost tracking
  • Failure to update accruals as trial stages change
  • Cost-to-completion estimates that don't reconcile to actual spending patterns

What investors scrutinize:

• • Do accruals reconcile to vendor contracts and site budgets?
  • How do you track costs across CROs, sites, and internal resources?
  • What assumptions drive your projections?

Underestimating burn forces companies into distressed capital raises or fire sales when runway evaporates. Investors have seen this pattern repeatedly, making clinical trial accounting a high-scrutiny area.

Dive Deeper: Biotech Industry Accounting Guide: From Discovery to Exit

Working Capital, Cash Flow, and Equity Structure

Working capital in life sciences extends beyond typical receivables and payables. Medical device companies carry significant finished goods and component inventory. Biotech firms have clinical supplies, prepaid trial costs, and deferred expenses. These items require clear documentation explaining what's carried, why, and at what value.

Cash flow analysis focuses on sustainability to the next value inflection point. Detailed projections tied to specific milestones, such as FDA approval, first commercial sale, and profitability, carry far more credibility than generic growth curves.

Cap table complexity creates its own challenges. Multiple preferred stock classes, extensive option pools, warrant liabilities, and convertible notes can create post-transaction dilution that affects valuation. Clean documentation showing implications across various liquidity scenarios significantly smooths due diligence. If you need help preparing for all of this financial planning, consider engaging a fractional life sciences CFO that brings the domain expertise needed to drive clarity.

Preparing Your Organization for Due Diligence

The best time to prepare for due diligence is long before you need it. Companies that maintain institutional-quality financial infrastructure year-round negotiate from positions of strength. Well-prepared companies typically complete due diligence faster and face fewer post-close adjustments than those scrambling to organize documentation.

Building a Well-Organized Data Room

A well-organized data room demonstrates operational discipline and reduces acquirer concerns. Structure matters as much as content. Essential components include:

• • Financial: Audited financial statements, monthly management reports, detailed trial ledgers with vendor-level tracking, complete revenue contracts
  • Regulatory: All FDA correspondence, complete clinical trial documentation, manufacturing and quality records
  • Legal/IP: Patent filings, licensing agreements, key employment agreements
  • Supporting schedules: Cap table details, equity compensation summaries, material contract summaries

Best practices for data room organization include creating intuitive folder structures (by category, then chronologically), maintaining an index document that guides reviewers to key materials, ensuring all documents are fully executed (no drafts or unsigned agreements), and updating materials in real-time as new information becomes available.

A disorganized data room signals weak internal controls and creates friction that delays transactions or prompts deeper scrutiny looking for hidden problems.

Addressing Red Flags Proactively

Common financial red flags include aggressive revenue recognition practices, incomplete accruals (particularly for clinical trials), weak internal controls, and any historical restatements: all of which may be signs of a dysfunctional accounting department. Regulatory concerns include outstanding FDA observations without clear remediation plans, delayed trial milestones relative to original projections, and manufacturing or quality issues affecting product approval timelines.

Don't hope these issues won't be discovered. Address them proactively through internal due diligence exercises—ideally with external advisors providing objective perspective. This allows you to identify and remediate problems before facing investor scrutiny.

Transparency about known risks typically yields better outcomes than attempted concealment, which inevitably damages trust and credibility when issues surface during formal diligence.

The Advantage of Audit-Ready Financials

GAAP-compliant financial statements are non-negotiable for institutional investors and strategic acquirers. What makes financials "audit-ready"?

Key characteristics include:

• • Consistent monthly close process (typically 5-7 business days)
  • Complete supporting documentation for all material transactions
  • Regular account reconciliations (particularly cash, receivables, accruals)
  • Clear policies for revenue recognition, expense classification, and estimates
  • Proper accrual methodology for ongoing obligations (trials, contracts, benefits)

Many early-stage life sciences companies struggle with inadequate expense tracking, grant accounting errors, equity compensation miscalculations, and unclear revenue recognition policies. Building a life sciences accounting function can be challenging, and external financial statement audits or reviews strengthen credibility and dramatically accelerate due diligence.

When acquirers trust your historical financials, they spend less time questioning your numbers and more time focused on strategic value and integration planning. This typically translates to smoother processes and better terms.

Strong Financials, Stronger Outcomes

Due diligence isn’t just a box to check: it’s a reflection of how well a company is run. Businesses with clear documentation, consistent financial processes, and proactive risk management enter transactions from a position of strength. They move faster, face fewer surprises, and ultimately secure stronger outcomes.

At G-Squared Partners, we help life science and biotech companies build the financial discipline and infrastructure that make this possible. Our fractional life sciences accounting and CFO services keep your financials audit-ready, your accruals accurate, and your business prepared to move when opportunity arises—not scrambling at the last minute.

Whether you’re preparing for a funding round or exploring strategic options, reliable financials give you leverage. They build investor confidence, streamline negotiations, and protect valuation. Our team works alongside you to create that foundation—so when the time comes, you’re ready to move decisively and on your terms. Contact G-Squared Partners today to discuss how we can help your life science company prepare for a smooth due diligence process.