Due diligence refers to the investigation and analysis a business or individual conducts before entering into any transaction, like investing in an enterprise. Due diligence is required by law for companies looking to purchase assets or businesses. It is also required by brokers to make sure their clients are informed before they agree to any transaction.
Due diligence is a requirement for investors when evaluating potential investments, which could be a corporate acquisition either through merger or divestiture. Due diligence can uncover undiscovered liabilities, like outstanding debts and legal disputes that can only be disclosed after the fact. This could impact a decision on whether to conclude a deal.
Due diligence can be classified into three categories: financial, commercial tax, and financial due diligence. Commercial due diligence focuses on a company’s supply chain and its market analysis and its growth prospects. A financial due diligence investigation analyzes the financial records of a company to make sure that there are no accounting errors, and to ensure that the company is on sound financial ground. Tax due diligence studies the company’s tax exposure and uncovers any tax owed.
Usually due diligence is restricted to a stipulated timeframe called the due diligence period in which buyers are able to examine the potential purchase and ask questions. Based on the type of deal the buyer may require expert assistance to conduct this study. Due diligence on environmental matters might include the list of environmental permits and licenses that are held by a company, while due diligence on financial matters may require an audit conducted by certified public accounting firms.
