The business world relies on the due diligence process on such a regular basis that it is often taken for granted.
However, it is worth reminding ourselves of the important role due diligence plays and how it helps companies make well informed decisions.
A Definition of Due Diligence
The term “Due Diligence” is used in business to describe to the process by which a purchaser will collect information and analyse a transaction before agreeing to or rejecting the deal.
The more thorough the due diligence carried out by a purchaser, the greater the chance they have of making a correct assessment of a transaction.
The following excellent explanation of the purpose of due diligence comes from www.investinganswers.com.
“Due diligence helps people and companies understand the nature of an investment, the risks of an investment, and how (or whether) an investment fits into a particular portfolio. Due diligence isn’t just good sense, it’s a duty investors owe to themselves — doing this sort of “homework” on a potential investment is often essential to making prudent investment decisions.”
The Facts Come First
The purpose of the due diligence process is to collect facts and information.
In the first instance it is not meant to generate immediate conclusions or opinions. Due diligence should be focused on gathering the facts and nothing but the facts of a particular situation.
It is typically up to the purchaser in a transaction to determine the information they need to make an informed decision. The purchaser must then present the requests for information and the seller will then collate the information and present their response.
Once all the facts have been gathered it is then possible for the relevant experts and professionals to analyse the data to assess the viability of the transaction. The quantity and quality of relevant and timely information that is gathered will directly affect the quality of the analysis of a deal.
Assessment of Risk and Opportunity
Every business transaction has an element of risk and an element of opportunity.
It is the duty of a purchaser to discover as much as possible about a particular transaction to identify those risks and opportunities.
For example: When buying a company, the purchaser must understand the level of obligations the company has – payroll, creditors, contracts, debts, legal, regulatory and environmental to name a few. Without a clear picture of these obligations a purchaser will not fully understand the risk they are accepting in buying the company.
On the other hand, there are opportunities to be identified as a result of the due diligence process. These opportunities include Information on regulatory changes that may give the company a new advantage in the marketplace, a new product may be in development but not yet announced or the introduction in new technology may dramatically reduce costs and increase margins.
It is important a purchaser uses the appropriate experts and professionals such as accountants and lawyers to assess both the risk and opportunity.
In summary, due diligence is the vital process by which companies gather and then analyse information about a transaction so they can make an informed decision.
The upfront effort placed into due diligence will potentially save or make millions of euros for a company. Company executives ignore due diligence at their peril.