Due Diligence

Meaning Of Due Diligence

Due diligence is an audit or investigation conducted by the company of the potential product or investment being planned by it. Due diligence reviews all financial records. It is a final precaution measure undertaken before entering into an agreement with another party.

Due diligence can be conducted on various events. Like, when the seller wants to investigate the authenticity of the buyer. Entities preparing for mergers and acquisitions also perform due diligence. Brokers are required to prepare due diligence as a compulsion before selling a security.

After knowing the meaning of due diligence, we will see the types of the same.

Types Of Due Diligence

The following are the types of due diligence:

Legal Due Diligence

This form of due diligence ensures that there are no legal issues involved in investing in a business or procuring it.

Tax Due Diligence

This due diligence focuses on making sure that seller’s firm does not hold any past tax liability that may be passed on to the acquiring firm.

Operational Due Diligence

This form of due diligence assists the prospective purchaser to get an analysis of the operational aspects of the target company.

Intellectual Property Due Diligence

This form of due diligence studies the various intellectual properties that the company may own.

Commercial Due Diligence

This form of due diligence aims at gaining an understanding of the market which the target company operates in.

Information Technology Due Diligence

This form of due diligence assists in identifying if there are any information technology concerns in the target entity.

Human resources Due Diligence

The human resources due diligence understands the impact of human capital on the planned deal.

On gaining an insight on types of due diligence, let’s understand the steps involved in the preparation of the same.

Process Of Due Diligence

The following are the steps involved in the process of preparing a due diligence:

Understand Compliance Concerns

In the ever-growing corporate world, the number of regulations imposed on the entity keeps increasing. The firm must gain an understanding of the compliance they need to match.

Define Corporate Objectives for Due Diligence

The due diligence process needs to align with the regulatory, strategic, reputational and financial risks which the entity may face.

Gather Key Information

Information of the entity needs to be gathered on a number of bases such as political connections, board members, incorporation documents, key shareholders, etc.

Screen Prospective Third Parties against Watchlists

Watchlist screenings can determine if the particular party poses any form of significant risks. The entity should be checked against points of law enforcement lists, global sanctions list, published lists of debarred companies, etc.

Conduct a Risk Assessment

A risk assessment must be prepared. The assessment must consider points such as high level of government involvement, country risk and financial risks arising due to deficiencies in internal factors.

Validate the Information Collected

After completing the risk assessment step, the next step in the due diligence process is to verify and validate all the information that has been procured.

Record the Due-Diligence Process

A record should be maintained through the due diligence process. The record should include all relevant assessments and documents. This record will later enable an entity to calculate the return on investments.

Establish an On-Going Monitoring Plan

The target party should be actively scrutinized throughout the process to avoid any form of unanticipated problems.

Review Your Due-Diligence Process Regularly

A business should keep adapting to changes. Periodic reviews should be conducted and required amendments should be incorporated in the due diligence process.

Conclusion

If any modification or addition in the entity is being considered such as a contract with a new supplier or takeover of another entity, a due diligence report will give the knowledge and confidence required to achieve the desired goal from the deal. A due diligence report detects issues that can be tackled early in the process. The findings can provide factual information thereby assisting an entity to determine the true value or cost of a business. The due diligence also contributes towards drafting of the agreement and enables the entity in negotiating the best terms.

References:

https://www.vskills.in/certification/tutorial/merger-and-acquisition/types-of-due-diligence/

http://www.investopedia.com/terms/d/duediligence.asp#ixzz4tQH8F8R9
https://www.lexisnexis.com/en-us/products/lexis-diligence/ctr/9-steps-to-effective-third-party-due-diligence.page