Due diligence is one of the procedure to investigate a business or person which normally occurs after the parties have decided to form an agreement but before a binding contract is signed.

Due diligence can be accomplished successfully by careful planning. Including the assessment of available resources, selection of management, estimation of risk, the recognition of the consequences of failure, definition of the deal’s scope, identification of possible obstacles to deal with and all of which lead to the crucial decisions essential to produce the results one wants to achieve.

Many investors, investment funds and lending institutions have essential criteria for business that they will invest. An overview of the business gained from the basic information enables an investor to plan the due diligence. All financial information, both public and private, constitutes the most basic information studied in due diligence. Such criteria includes financial ratios, historical earnings, projected earning potential, tangible book value in relation to price, type of business and quality management. These criteria give an indication of what investors hope to get for their money, such as income to offset losses, increased market capability or new facilities.

While planning the scope and nature of a due diligence, an investor must implement a risk assessment to determine the degree of business and legal risk that he/she will accept. Scope in this context includes the depth of questioning on any subject and the quantity of original documents to be reviewed. Nevertheless, well-run due diligence program cannot guarantee success for investors.

When an investor seriously considers a business opportunity, a list of information and documents may be required to contain all essential data yet avoid the superfluous. Due diligence will be involved in almost every aspects of business transactions and all business persons, including the professionals representing them or be involved in the transaction. It is crucial to conduct proper due diligence or otherwise could lead to other implications, such as liability to third parties or criminal liability. Additionally, any persons such as attorneys, accountants, broker/dealers, appraisers and other professionals may also find themselves being sued by their clients or by third parties not conducting a proper due diligence.

Questions to be asked:

1. What is the legal name of the business?

2. What is the address, telephone and FAX number of the business’s headquarters and/or the owner?

3. What are the names, telephone numbers and addresses of the principals involved in negotiating this transaction?

4. Review the following documents:

  • Five years of financial statements.
  • Five years of tax returns.
  • Last 12 monthly financial statements.
  • Five years of annual reports, proxy statements and SEC filings (if public).
  • An organization chart showing personnel and reporting relationships.
  • Reports of security analysis if a public company.

One basic part of any due diligence is to determine how the business is financially and legally structure and who owns each unit. This should be confirmed for each legal entity under consideration, including joint ventures, subsidiaries, partnerships and other business entities. For every business, documents describing the legal structure should exist and must be located and reviewed. If the company’s common shares are publically traded, the price and volume history will be of intense interest. Ideally, daily reports of price and volume should be recorded when there is slightest interest in the company.

One of the main reason to conduct due diligence is to avoid bad business transactions and unexpected liabilities that may accrue a person in a transaction. Not only will the appropriate due diligence procedures would alert investors and professionals to potential unwanted liabilities, but to proof of proper due diligence may serve as a defense against third-party claims after the transaction is completed.

Conducting a proper due diligence is important in every business transaction, not only for investors, but for the professionals representing them. Failure to conduct proper due diligence may result in civil liability to third parties, with damages reaching into millions of dollars. In addition to civil liability, investors and professionals may also face criminal liability for not taking due diligence seriously.



Gordon Bing, Due Diligence Techniques and Analysis (1996).


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