Due Diligence: Meaning, Applications, and Benefits

Giving something its “due diligence” is a phrase that is part of today’s casual lexicon, usually meaning “doing a bit of extra research” or “looking into” something. Look up the meaning of “due diligence” in a dictionary, and it may tell you the phrase has been in use since the 15th century in much the same way, simply meaning “requisite effort”. 

However, in the business and financial worlds, due diligence’s meaning is very specific, describing a complex and specialist process that requires research and fact-finding, analysis and expert discussion. Here, we explore due diligence in-depth, answering questions like, “What is due diligence?”, “How does it work?”, and “Who can benefit from it and why?”. 

What Does Due Diligence Mean?

Due diligence is an assessment or review made in the context of a potential business opportunity or high-stakes transaction, such as a merger or acquisition. Due diligence involves investigating and assessing relevant risk so that the most informed decision can be made before entering into a new business arrangement with confidence. 

There are several context-specific due diligence definitions that you may come across, including:

• Financial and investment due diligence, which involves a deep dive into financial records to verify the financial health of a third party, examine profitability, and to make well-informed projections. 
• Legal and regulatory due diligence, which is when legal documents are reviewed for compliance and searched for hidden liabilities and ongoing or potential legal issues. 
• Technical due diligence, where the technical areas of the business are fully reviewed for potential risks.
• Commercial due diligence, which takes a detailed look at the relevant market and commercial viability.   

The type of due diligence needed will depend on the nature of the transaction and the nature of the business. 

What Is Enhanced Due Diligence?

Enhanced due diligence is the name given to the most thorough assessment possible and it goes beyond the standard due diligence process. Enhanced due diligence is used in the highest risk scenarios when, for example, there is a chance of detecting money laundering, the financing of terrorism, or other financial crimes. 

What Is Customer Due Diligence?

This type of due diligence research screens potential customers to prevent risk to the business. It’s a legal check that confirms customer identity and confirms that they are not involved in illegal activity, usually in the context of high-value transactions like property. 

What Is the Role of Due Diligence?

In all contexts, due diligence is a proactive process that seeks to gather as much relevant information as possible, before analyzing it and using it to assess risk. It has become the norm in business practice for responsible, compliant and prudent companies before entering into a new arrangement. This is because it fulfills the following purposes:

The due diligence process systematically gathers relevant data.

Due diligence is a structured, methodical and checklisted process carried out by experts who are meticulous in their investigations. The result is that stakeholders are presented with a thorough picture where no stone was left unturned. 

The due diligence process presents detailed information to stakeholders and decision-makers.

The process ensures that full disclosures are made and all relevant parties are informed of all the necessary details of a transaction before they make any commitment. Both shortcomings and strengths will be highlighted. This enables educated decision-making. 

Due diligence gathers unbiased advice from independent experts.

Assigning the process to independent experts in financial due diligence means that all parties can benefit from unbiased opinions on the potential benefits and pitfalls of any transaction. 

Due diligence can help manage risk.

The due diligence process identifies risks and their magnitude, ensuring that all parties go forward understanding what risks the transaction exposes them to. 

Due diligence ensures compliance and is protective for all parties involved.

Due diligence is about transparency, seeking to uncover all risks and liabilities, so that all parties are fully informed, lessening the chances of litigation from either party later on. It also ensures that all parties, business processes and the transaction itself are compliant with relevant laws and regulations, minimizing the risk of fines or prosecution.   

Who Benefits from Due Diligence? 

Due diligence is essential to businesses in a variety of situations. Due diligence can be instigated by: 

• Investors looking to assess the viability and risk of potential business investments. 
• Executives and business owners needing to evaluate the potential benefits and risks of potential mergers and acquisitions or new partnerships. 
• Legal professionals seeking to ensure compliance and identify legal risks associated with a transaction or opportunity. 
• Accountants and finance professionals needing to verify the financial status and health of a third party. 

However, due diligence is not always instigated by a buyer or investor. Due diligence can also be used by sellers looking to prepare as thoroughly as possible for a streamlined transaction. 

The Due Diligence Process

Here is an overview of how complex and detailed the process is. In practice, due diligence is a bespoke service that is tailored to a specific transaction, business and industry context and it can therefore vary in scale and scope. However, this checklist outlines a broad idea of what to expect. 

Stage One: Goal Setting

All stakeholders and the business consultants conducting due diligence discuss the nature of the proposed transaction and the overarching aims of due diligence in this context. This enables a bespoke process to be designed that will provide stakeholders with all the evidence and information they require to make a confident decision later. 

Stage Two: Information Gathering and Analysis

Here is an insight into the what documents  are required for due diligence: 

• Financial and tax records
• Customer information
• Supplier contracts
• Information on property and other assets
• Insurance policies
• Employment data
• Data security information
• Risk management policies
• Patents and trademark information
• Litigation records.

These documents are then closely analyzed for irregularities and red flags, as well as to build a comprehensive picture of the health of the business being investigated. 

Stage Three: Forecasting

The evidence from stage two is then used to calculate the potential benefits and risks of entering into the proposed transaction. Business consultants and advisory services can identify the likely profitability of entering into the arrangement, flag potential litigation, tax and compliance issues, and assess risks related to technology infrastructure, employment, assets, suppliers, data and any other issues as relevant to the specific context.

Stage Four: Reporting

A full due diligence report of everything discovered during the assessment stage, along with highlighted red flags, strengths and weaknesses, plus forecasts, can be presented to stakeholders so that they can decide the next steps.

Due Diligence For Your Business

If you are planning or considering any major business transaction, due diligence will be a crucial safeguarding step to minimize risk and maximize the benefits of the next step in your business journey.

Book a free initial consultation with us and learn how we can help you achieve your project goals.