What is a Due diligence?
Due diligence is an investigation or audit of a potential investment or product. It refers to the research done before entering into an agreement or a financial transaction with another party.
The purpose of a due diligence process is to give the purchaser the opportunity to make an informed decision about what they are about to buy. By investigating the subject of the purchase, the purchaser can properly assess the costs, benefits and risks associated with it. The process may also help to prevent future disputes between the parties.
This due diligence investigation enhances the amount and quality of information available to the purchaser. It enables the purchaser to make a decision in a systematic and reflective way. It provides crucial assistance to the purchaser in determining the final price of a purchase.
Firstly, a due diligence process will consist of a review of the financial matters of the target company. These can include the accounts, tax matters, guarantees, debts and outstanding financial liabilities. The review is important because if the target company's obligations are to pass to the purchaser, they need to be factored into the purchase price.
Secondly, a due diligence process will include a review of the target company's assets. These can include real estate, production facilities and intellectual property rights. The latter can be contracts, licences and patents. An assets review should also look at all founding documents of the company, such as the owner agreements and articles of association.
Thirdly, many potential buyers or investors will also make inquiries of the target company's marketing strategies, IT systems and modes of management. This may involve a SWOT analysis - the identification of the company's strengths, weaknesses, opportunities and threats.
If you are selling a business and the purchaser wishes to conduct a due diligence process, it is a good idea to insist that they sign a confidentiality or Non-Disclosure Agreement first. A potential purchaser gains an inside look at a company's affairs during the process and may be privy to trade secrets and other confidential information. You may also insist that the due diligence process is carried out in a closed and supervised room, at a predetermined time.
Purchasing property always involves a due diligence process. After the purchaser makes an offer on the property, there follows a period during which the purchaser will have the home inspected and investigate possible neighbourhood downfalls. During this due diligence period, the purchaser will work with their lender to review the transaction before it comes into effect.
Similarly, patent applications involve a due diligence process. The examination is conducted to ensure that the patent company meets the requirements to create the patent and is not just engaging in anti-competitive behaviour.