Due diligence is the process of investigation and analysis a business or individual conducts prior to entering into any transaction, such as investing in an enterprise. The process is generally mandated by law for companies looking to purchase other assets or businesses and by brokers who wish to ensure that their client is fully informed about the specifics of a transaction before committing to it.
Due diligence is a requirement for investors when considering investments which may include an acquisition or merger, or even a divestiture. Due diligence can uncover undiscovered liabilities, such as legal disputes or outstanding debts, which would be revealed only after the fact, which might affect the decision to close the deal.
Due diligence can be classified into three types: commercial, tax and financial due diligence. Commercial due diligence focuses on a company’s supply chain, market analysis and growth prospects while a financial due diligence analysis examines the company’s financial books to make sure there are no accounting errors and is financially sound. Tax due diligence studies the company’s tax exposure and also identifies any outstanding tax.
Often due diligence is limited to a stipulated timeframe known as the due diligence period during which buyers can assess the purchase and ask questions. Depending on the type of deal, a buyer might need professional assistance in conducting the research. For example environmental due diligence may concentrate on a list of all environmental permits and licenses the company has, while financial due diligence may require a review by certified public accountants.