What is Due Diligence?
Due diligence refers to the comprehensive investigation or vetting of an individual or company before entering any business transaction. This is usually done during mergers and acquisitions, investments, or partnerships.
Throughout the process, the investigator or analyst reviews all relevant facts and information to gain an overview of the other parties’ financial health, risks, and growth potential. At its core, due diligence must be proactive rather than reactive to uncover potential issues and opportunities before making any decisions.
Conducting due diligence protects all parties involved. Guaranteed that all information shared in a business deal is accurate and complete, this process reduces the chances of any undisclosed debts and legal liabilities.
Who performs due diligence?
Due diligence can be conducted by a range of stakeholders, depending on the deal. Buyers and investors often initiate it to verify what’s being presented by the seller. At the same time, sellers may also perform their own due diligence to prepare for negotiations or identify potential concerns early. To provide subject-matter expertise, especially in the legal aspects of the transaction, lawyers, accountants, and consultants are often brought in along the way.
Types of Due Diligence
Due diligence typically falls into two main categories: hard due diligence and soft due diligence. Hard due diligence focuses on numbers and compliance, while soft due diligence examines less tangible yet equally important aspects, such as culture and leadership of the company.
Hard due diligence includes:
- Financial Due Diligence: Reviews income statements, balance sheets, cash flow, and projections to ensure accuracy and sustainability.
- Legal Due Diligence: Covers contracts, intellectual property (IP) rights, licenses, employment policies, and litigation to identify legal risks.
- Tax Due Diligence: Examines tax history, audits, liabilities, and compliance to uncover potential tax issues.
- Operational Due Diligence: Evaluates daily operations, including supply chain, IT, service delivery, and processes to ensure scalability and integration potential.
On the other hand, soft due diligence includes:
- HR Due Diligence: Reviews employee contracts, compensation, benefits, turnover, and HR issues to get a glimpse of the company culture and leadership structure.
- Administrative Due Diligence: Verifies corporate documents, governance structures, insurance, and policies to ensure all information is current and compliant.
- ESG Due Diligence: Assesses the company’s sustainability practices to align with investor expectations.
- Commercial Due Diligence: Analyzes market position, customer base, competition, and growth potential to evaluate the business model’s strength.
Process and Timeline Management
Due diligence isn’t a one-size-fits-all procedure. Some deals may require fewer steps, while others may involve extra layers of review and take longer to complete. But generally, the due diligence process is divided into three key phases:
- Preliminary Assessment: The early phase begins with a preliminary gathering and review of the company’s relevant information, including financial data and market position. The goal is to identify any immediate red flags or areas that may require deeper investigation. During this stage, the due diligence team is assembled, bringing in specialists such as lawyers, accountants, and industry experts.
- Detailed Investigation: The second phase involves a systematic and in-depth review of the company. Financial records, contracts, legal documents, and other key materials are closely examined. This is often accompanied by management presentations, where key executives provide deeper insights into the company’s strategy, operations, and potential challenges. Site visits may also be conducted to inspect facilities, equipment, and daily operations.
- Analysis and Reporting: In the final phase, findings from the investigation are compiled and analyzed. This step includes addressing uncovered risks and evaluating their potential impact on the business transaction. Meanwhile, opportunities for value creation or operational improvement are also identified. The outcome of this phase is a set of clear recommendations, covering everything from deal terms and pricing to whether the transaction should proceed.
The timeline for due diligence can vary greatly depending on the complexity and scope of the business deal. While a simple transaction might be completed in 2 to 4 weeks, more complex or multinational deals can take anywhere from 3 to 6 months.
This comprehensive guide will give you more information about due diligence: What is Due Diligence: Definition, Types, and Ways to Conduct.