Due diligence is the term used to cover a wide variety of investigations during a business deal. There are many types of due diligence, including asset, legal, environmental, and even human resource-related investigations. In general, due diligence is an investigation conducted before closing a business transaction. Primarily conducted by the party that is financing or buying an asset or liability from the other one.
When you buy a house or car, you might hire a professional inspector to look at it first. When you sign a contract with a company that wants to use your intellectual property, you might hire an attorney to review it first. When you’re thinking about investing in a new business or buying a stake in it, you guessed it; you should perform due diligence first.
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What is Due Diligence?
Due diligence is often used by companies who are considering making an investment in another company or product.
The goal of due diligence is to make sure that you’re getting what you pay for, and that you don’t end up buying something that is not favorable to you. Due diligence investigations are done by professionals who have a lot of experience in the industry. They’ll typically investigate everything from the financial statements to the physical assets of the business.
As mentioned, there are many different types of due diligence, so, in this article, we will take a look at each type together with its purpose and requirements.
Corporate Due Diligence
Corporate Due Diligence is a process by which an organization seeks to understand the nature of a target company, its business, true value, and the risks involved in acquiring it.
Corporate due diligence is often used when an organization is considering acquiring a stake in another company, or when it plans to merge with another entity. It can also be used as part of an exit strategy for an investor or owner who wants to sell their company.
The goal of corporate due diligence is to understand all aspects of the target business and its operations in order to make informed decisions about whether or not to proceed with the acquisition.
The process generally involves a number of steps, including:
- Reviewing financial statements
- Examining legal documents
- Meeting with management.
- Conducting background checks
Financial Due Diligence
Financial due diligence is a process of analyzing the financial information provided by a potential business partner or target company. The goal of this type of due diligence is to identify risks, determine the strength and stability of an organization’s finances, and ultimately decide whether or not to pursue a business deal with them.
Financial due diligence can be performed in-house or by an outside firm on the buyer’s behalf. If performed internally, the team responsible for conducting financial due diligence should include individuals with accounting backgrounds and experience in some aspects of finance (such as accounting or auditing). They should also have experience working within the specific industry or sector that the target company belongs to.
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Financial Due Diligence involves a range of tasks, including but not limited to:
- Reviewing the financial statements of the target company.
- Interviewing the management and board of directors of the target company to understand its business model and strategy.
- Comparing the performance and profitability of the target company with that of its competitors in similar industries or markets, as well as with industry benchmarks for similar companies based on size and other factors relevant to performance metrics such as revenue growth, profit margins, and debt levels.
Administrative Due Diligence
Administrative due diligence is the process of reviewing, verifying, and validating the administrative processes of a company that may potentially be acquired. It is performed by a third party who is not involved in the day-to-day operations of the business in question. The purpose of administrative due diligence is to ensure that the target entity has effective internal controls and procedures in place to manage its operations, as well as to verify that any legal administrative requirements are being met.
Administrative due diligence can also include reviewing or verifying information about an entity’s employees or suppliers, such as employment contracts or vendor agreements.
How administrative due diligence can help you:
- Helps to ensure that a company is not buying into a bad business or investing in an unethical one.
- Identifies and mitigates risks of fraud and corruption, which can be costly for investors and shareholders alike.
- Can help avoid costly lawsuits by identifying potential liabilities early on.
- Helps you to spot potential opportunities for the target company.
Taxes Due Diligence
It’s the process of reviewing the target’s finances and identifying any issues that may be causing problems with the tax filings of the company, or might create issues in the future. It’s similar to financial due diligence. You want to make sure that everything is up to date with the target company’s taxes so that your taxes are filed correctly and on time.
Some of the benefits of tax due diligence include:
- Tax Due Diligence can help you identify new opportunities to reduce your tax liability.
- It can help you avoid penalties and fines that could be levied by government authorities.
- It will help you prepare for audits more efficiently, by providing a clear paper trail of all transactions.
- It can also provide insight into the potential impact of proposed legislation on a business.
Operational Due Diligence
Operational due diligence refers to a process that companies use to ensure that their partners or the target company are doing business in a legal and ethical way and that they do not pose any risk to the organization.
The purpose of operational due diligence is to provide assurance that an acquisition or merger can be managed properly and with integrity, both from an operational perspective as well as from an ethical perspective.
Operational due diligence involves activities such as:
- Visiting the physical location(s) of the business
- Reviewing operation procedures and processes
- Interviewing key personnel at all levels of the organization (from CEO down to frontline employees)
- Reviewing employee handbooks and other policies and procedures related to employee relations, safety, etc.
Human Resource Due Diligence
Human Resource Due Diligence is a process that assesses an organization’s human resource systems. It helps identify and correct issues that may be contributing to employee dissatisfaction, turnover, or other problems.
The purpose of HRDD is to provide better insights into key aspects of the target organization’s human capital management (HCM). It enables investors to accurately measure the effectiveness of the HR practices and identify potential areas for improvement in their practices when acquiring a firm.
HRDD activities include:
- Reviewing the company’s website and social media presence.
- Interviewing current employees who are familiar with the culture.
- Interviewing former employees who were let go.
- Reviewing third-party references.
Intellectual Property Due Diligence
When you’re about to purchase a business, it’s crucial to perform Intellectual Property Due Diligence. This process involves getting the necessary information about the intellectual property (IP) of a business before buying it. It’s important to be aware of all the IP that the company owns or has filed for, as well as any licenses, patents, or trademarks it holds.
There are plenty of reasons why this is so important: if you buy a company and have no idea what its IP looks like, you could end up paying too much money or entering into an unwarranted contract. You might also find yourself at risk of having your own IP infringed upon by another company.
Some of the main benefits of Intellectual Property Due Diligence include:
- Identify potential lawsuits
- Ensure that you’re not infringing on other companies’ IP
- Ensure that your own intellectual property is protected
- Identify potential new opportunities for your company’s IP
- Save money on legal fees and other costs
Strategic Due Diligence
Strategic Due Diligence is a process that can be used to analyze the strengths and weaknesses of a potential target business, in order to determine if they are a good fit for your company. It’s also called “Strategic Assurance Review” or “SAVR” (Strategic Assurance Verification Review).
The goal of Strategic Due Diligence is to provide an objective analysis of a target company’s, management and financial strength; this helps you decide whether or not it’s worth acquiring or dealing with that business.
Strategic due diligence can help you to:
- Prevent the most common types of risk from affecting your company
- Identify opportunities for growth and expansion that you didn’t even know existed before
- Gain a better understanding of the value chain, including suppliers and partners
- Make more informed decisions about which markets are worth entering into, based on the state of those markets and their potential for growth over time
Legal Due Diligence
Legal Due Diligence is a process that helps companies investigate the legal status of a business deal or other transaction. The goal of Legal Due Diligence is to find any potential problems before the deal is finalized.
Legal Due Diligence is used in many areas of business, including mergers and acquisitions, joint ventures, licensing agreements, and other types of agreements. In each case, it’s important for parties to have an understanding of their legal rights and responsibilities before entering into a deal or agreement.
Activities when performing legal due diligence include:
- Review of the contract between the parties, including any warranties or representations made by the party
- Review of any agreements between vendors and third parties
- Checking for potential violations of law or regulations
- Verifying that all forms are properly signed and executed by authorized personnel
Even as you’re reading up on the different kinds of due diligence, you should also know how to navigate the due diligence process. When you’re ready, take a look at this video I have created. you’re sure to find it helpful.
Environmental Due Diligence
Environmental Due Diligence (EDD) is a process that helps organizations identify, assess, and manage the risks associated with their business activities. It involves identifying any potential environmental impacts of a business or project, as well as identifying any existing environmental issues that may make the business a less desirable option to acquire for an investor.
Environmental Due Diligence is most commonly used by companies that are looking to acquire a new business or site, or who are planning to make significant changes to their existing operations.
The activities in environmental due diligence typically include:
- Reviewing historical data on environmental issues at the company, including previous incidents and compliance with regulations
- Conducting an investigation into current conditions at sites where there has been no record of past incidents
- Identifying potential impacts on natural resources, including water bodies and habitat
- Reviewing regulatory compliance for all sites and facilities owned by the target
Asset Due Diligence
Asset Due Diligence is a process in which a buyer of an asset or business conducts due diligence on the assets and liabilities of the target company. The buyer may also conduct similar background checks on the team members and other stakeholders involved in the sale.
The purpose of Asset Due Diligence is to ensure that both parties are aware of any potential risks that may be associated with the transaction. This includes any existing or future lawsuits, legal liabilities, and environmental issues.
Here are some of the ways that Asset Due Diligence can help you:
- Helps you identify issues with the asset before they become problems
- Helps you to reduce fraud, corruption, and other financial crimes
- Helps you better understand the risks associated with the asset
- Gives you a better view of how well-suited the asset is for your business
IT Due Diligence
IT due diligence is a process that can help you identify the risks and opportunities associated with a business relationship. It is a common practice for investors to perform IT due diligence when buying an IT company or its products. In addition, companies may perform IT due diligence for their partners, vendors, and suppliers as well.
For example, if you are evaluating whether or not to purchase software from another company, you may want to conduct IT due diligence on them. This will allow you to assess whether or not they have any security issues or other issues that could cause harm to your business.
IT Due Diligence involves:
- Assessing the current environment, infrastructure, and tools being used to support the new system or application
- Establishing a baseline of current system performance
- Identifying any potential risks to the project from changes in technology, new platforms or changes in team members
- Creating an IT Due Diligence Plan to manage those risks
Hopefully, this article has given you a sense of the most common forms of due diligence and how they can help buyers and sellers alike. When buying or selling a business, there are many issues that can get in the way of things going smoothly.
Knowing how to navigate these problems is key to moving forward and coming out on top. Make use of all the information you have available to you during your negotiations, and you’ll be off to a much better start.
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