Due diligence is a commonly used legal term, but it also has many applications in business. Here, we’re going to look at some examples of due diligence in business and how to make your due diligence process a seamless one.
What is due diligence in business?Due diligence is the systematic examination of a business ahead of an event such as a merger or acquisition, capital raise, IPO, or audit. It is the investigation carried out prior to a financial transaction to assess commercial and legal risks, as well as opportunities.
Read more: What is due diligence in business?
Due diligence before buying involves a rigorous examination and evaluation of a target company’s critical documentation and data. It must be conducted before a binding agreement is signed between parties. This ensures that all risks have been disclosed and all opportunities are on the table before the M&A deal proceeds.
For early-stage companies looking to secure investments, the startup due diligence process is essential. If it doesn’t go smoothly, potential investments can go south - fast.
Types of due diligence and who performs itBroadly speaking, we can break due diligence down by role, by outcome and by type.
By roleDue diligence (DD) is performed by people in the following roles:
- Companies looking to acquire other companies
- Private equity (PE) or venture capital (VC) investors seeking opportunities
- Fund managers
- Asset managers
- Financial analysts and advisors
On the other side, the documentation and data for due diligence needs to be prepared by:
- Companies seeking investment
- Business owners preparing to merge or sell their business
- Companies looking to IPO
By outcomeA common need for due diligence is M&A. However, it’s also necessary in all sorts of business investment situations.
- Capital Raise
- Business Exits
- Post-Acquisition Integration
- Strategic Review
- Audits & Compliance
- Portfolio/Asset Management
By typeBelow are some of the different types in M&A. As the process can vary by industry and by event or transaction type, this is by no means an exhaustive list, but a good starting point to understand the depth of assessment required.
- Financial DD
- Legal DD
- Tax DD
- Operational DD
- Intellectual Property DD
- Commercial DD
- Information Technology DD
- HR due diligence
- Regulatory DD
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What are the two types of due diligence?So now we know a bit more about what is due diligence. Exercising due diligence requires an in-depth look at annual reports and other data to get to the facts - but some aspects are more easily quantifiable than others. This divides DD into two categories: hard vs soft due diligence. While hard DD is easy to ascertain in numbers and figures, soft DD requires a different approach.
What is hard due diligence?Hard due diligence addresses concrete data and facts. It focuses on the financial aspects of the business, such as financial statements, expenditures and projects. This is the primary type of DD that is used to assess whether profit can be generated from the deal.
What is soft due diligence?Soft DD is equally important, though harder to conduct. This assesses the human capital of a business, including talent, skills, culture and leadership. It aims to establish whether key staff members are likely to stay or leave in the event of the deal going through. When M&A deals fail - which is 50% of the time - it is usually because this human element is ignored (Investopedia).
In its basic form, the due diligence process consists of the purchaser asking questions of the target business, and the business answering those questions with proof that shows they have answered. The bidder is legally obligated to disclose accurate information. There is then a rigorous due diligence Q&A process to clarify anything that might need further explanation before the purchase.
The due diligence process
DD is usually conducted after you and the acquiring firm have agreed in principle to a deal, or at least that one may be beneficial, but before any binding contract is signed.
Find out more: How do you perform due diligence
The purchaser should consider every area of the target’s business and seek to uncover as much detail as possible about its current state of health before making their investment decision. During this process, they should spend time talking to management and key staff, understanding what documents will help confirm the viability of the transaction, and verifying the integrity of all the information that is provided.
Main things the buyer should consider
Purchasers should also consider their integration strategy, and how the new business entity will operate as a unified whole in order to maximize synergies.
Potential warning signs for the buyer include any unverified, inaccurate or missing material information that could prove to be problematic later on. This could mean the prospective bidder is hesitant to share something that could be perceived as a red flag, or that they are disorganized and don’t actually know these details about their own business.
Potential warning signs for the purchaser
According to Accru, other warning signs to watch for include:
- declining customer numbers and/or turnover;
- indications that the industry itself is moving into a difficult period.
To perform due diligence, companies and their advisors need to carefully scrutinize every aspect of a prospective bidder. If there are gaps in the documentation they gather, they risk missing critical information that could see them fail to reach a high valuation and sale price. Even worse - it could impact the future of their business.
Risks of conducting improper due diligence
Poor organization can result in the discovery of risks late in the process if a company has exercised due diligence improperly. This creates stress for both parties, costs time to resolve, and increases the chances that the deal will fall through.
Due Diligence ChecklistBuying a business is a costly endeavour, so it’s important you are confident you have all the information you need to make a well-informed decision.
Ansarada’s Due Diligence Checklist lays out the framework for everything the seller needs to provide and the buyer needs to consider in order to progress the deal. It is a file structure that has been built from 50 million data points across 35,000 deals to help you organize your business data and ensure nothing gets missed.
With Ansarada, you get more than a checklist. Now, the modern-day dealmaker can utilize 'Pathways' to automate the due diligence process from beginning to end. Request a demo of the Ansarada data room software and we’ll show you how Ansarada Pathways can help you set up a digitized workflow to make due diligence seamless, efficient, and risk-free in 2020 and beyond.
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