Meaning
Due diligence is an audit or investigation, which a company of the potential product or investment conducts. It reviews all financial records. It is a final precaution measure one undertakes, before entering into an agreement with another party.
The company can conduct due diligence on various events. Like, when the seller wants to investigate the authenticity of the buyer. Entities preparing for mergers and acquisitions also perform this activity. Brokers need to prepare it as a compulsion before selling the security.
After knowing the meaning, we will see the types of the same.
Types Of Due Diligence
Legal
This form of due diligence ensures that there is no involvement of legal issues in business investment or procurement.
Tax
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
This form of due diligence assists the prospective purchaser to get an analysis of the operational aspects of the target company.
Intellectual Property
This form studies the various intellectual properties that the company may own.
Commercial
This form aims at gaining an understanding of the market which the target company operates in.
Information Technology
This form assists in identifying if there are any information technology concerns in the target entity.
Human resources
The human resources due diligence understands the impact of human capital on the planned deal.
On gaining insight on types, let’s understand the steps involved in the preparation of the same.
Process Of Due Diligence
The following is the step by step process:
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
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
There has to be the preparation of the risk assessment. 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 Process
One should maintain a record 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
There has to be proper scrutiny throughout the to avoid any form of unanticipated problems.
Review Your Process Regularly
A business should keep adapting to changes. Periodic reviews should be conducted and required amendments should be incorporated in the 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. This report detects issues that one can tackle early in the process. The findings can provide factual information thereby assisting an entity to determine the true value or cost of business. The due diligence also contributes towards the drafting of the agreement and enables the entity in negotiating the best terms.1–3
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