Meaning of “Due Diligence”
The term “due diligence” is, generally used for various concepts involving investigation of either a person or business before signing a contract, or an act involving certain standards of care. One of the common examples of due diligence in different industries is the process by which a prospective acquirer estimates the target company or its assets for acquisition.
Due diligence, in business transactions and corporate finance, can defined in different ways as follows:
1. The evaluation of a prospective target for amalgamation, privatization, acquisition, or related corporate finance transactions by a buyer.
2. Due diligence is also defined as a reasonable investigation which focuses on material future matters.
3. Another definition of due diligence is given as an evaluation being attained through certain questions like what do we buy, how much do we pay, and how to structure the acquisition.
4. Due diligence is also defined as an evaluation aimed at making a decision for acquisition through the principles of valuation and shareholder value analysis.
Different areas of due diligence
The framework of due diligence varies according to the different types of companies. The process of due diligence can be categorized into nine different areas:
1. Reconciliation audit
2. Information systems audit
3. Management audit
4. Production audit
5. Marketing audit
6. Legal/environmental audit
7. Macro-environment audit
8. Financial audit
9. Compatibility audit
Reasons to conduct due diligence
The chief reasons leading to due diligence are:
- Confirming that the business is actually what it appears to be
- Recognizing the probable “deal-killer” defects in the target to avoid a bad business transaction
- Gaining info which is helpful in evaluating assets, defining representations and warranties, as well as negotiating price concessions.
- Verifying the compliance of the transaction with acquisition or investment criteria.
Who conducts due diligence?
The process of due diligence is conducted by lead and co-investors, attorneys, accountants, attorneys, corporate development staff, investment bankers, loan officers, and similar professionals involved in the transaction.
When is due diligence conducted?
The initial collection and evaluation of data begins as and when a business opportunity arises and persists throughout the talks. A detailed due diligence is conducted once the involved parties have agreed in the principles of a deal.
- Debt ratios
- Liquidity ratios
- Profitability ratios
- Asset management ratios
- Cash Flow Indicator Ratios
- Market value ratios
- Financial analysis
- Business Terms
- Financial education
- International Financial Reporting Standards (EU)
- IFRS Interpretations (EU)
- Financial software