What does conducting due diligence mean in practice?
In many industries or sectors, you may have heard of the term due diligence or been asked to conduct due diligence in some way. But what exactly does due diligence mean? And what does conducting due diligence mean in practice?
Here, we look at explaining the due diligence process and what it means across different sectors. For the due diligence meaning in real estate, is different to the due diligence meaning in law as is due diligence in business sectors such as banking and finance. Plus, there are several types of due diligence that we will investigate. While there is a basic due diligence process in theory, there is also contingent due diligence and a process called enhanced due diligence. It is necessary to understand all fully to ensure that you stay within the useful realm of the due diligence process.
A performed due diligence means that a person or entity has undertaken care and effort in fully understanding another company with which they intend to do business. There are a number of steps that should be followed in the due diligence process. Plus, there are several types of performed due diligence which we investigate below. They vary in terms of what purpose the performed due diligence process is being conducted for.
Due diligence in real estate is exceedingly common. In fact, for anyone who has purchased a house or sold a property, they will have been part of a due diligence process, even if it was not called that. It is the process which finds out if there are any issues with the property which the buyer should know before the final purchase.
Some of these findings could affect a person’s ability to access funding from a bank in terms of a mortgage or loan to purchase the property. The common features that due diligence in real estate will have are:
An example of the due diligence process in real estate would be a survey of a property for a sale by a professional and registered agent. The findings from the survey would then be given to the buyer so that they can make a fully informed decision as to whether to pursue purchasing the property.
Due diligence with regards to law is the process by which a company is obligated to conduct an audit of any future transactions or investments they express a wish to make. Importantly, the companies with which they hope to do business are legally obligated to give them all the information needed to understand all risk factors involved in the transaction.
An example of due diligence in law would be a Mergers and Acquisitions department of a bank carrying out a thorough investigation of a firm that another firm would like to buy. In this instance, the bank must investigate both entities and it must be fully transparent in all of its findings.
It is not to be confused with legal due diligence which is the process of investigating a company’s legal health with regards to any outstanding contracts or other legal documents. Legal due diligence can therefore be seen as part of the larger due diligence process. This is because companies will want to read relevant documents or compliance procedures as a means of uncovering any bigger issues. An example of this would be reading through some board meeting minutes or examining how the company has dealt with complying with the GDPR.
Due diligence in business is largely viewed as good practice in how to act in all transactional proceedings. While this can definitely include buying whole entities themselves, it also refers to other purchases such as buying software, hardware or any other buoys that require company funds. The hope is to ensure only good purchases take place that meet the needs and requirements of the wider firm.
An example would be purchasing a new piece of commercial software for a business. To do proper due diligence, an investigation into the pricing of the product is necessary as well as:
Contingent due diligence is when an entity has confirmed that they are interested in a seller’s offer, but first have to carry out their own investigation into both the offer and the seller themselves. The transaction can go ahead only if the contingent due diligence does not expose any reason for concern. I.e the deal is contingent upon the due diligence’s results.
Enhanced due diligence is the same as due diligence, only it investigates firms, entities, individuals and offers even more deeply. The idea is to gain even further knowledge to ascertain all risks involved and whether they can be mitigated satisfactorily.
While conducting due diligence can be seen as a tiresome and laborious process, it is crucial to do it thoroughly. Without it, you leave yourself open to the risk of the unknown. It may seem like a jargon type term, but due diligence is simply the process of giving yourself the information to make a fully informed decision before making any purchases or sales. As a result, it minimises your losses in the future that could have been circumnavigated if you had been more thorough before signing the dotted line.