Overview of Due Diligence

Due diligence is a process of verification, investigation, or audit of a potential deal or investment opportunity to confirm all relevant facts and financial information, and to verify anything else that was brought up during an M&A deal or investment process. Due diligence is completed before a deal closes to provide the buyer with an assurance of what they’re getting.

Importance of Due Diligence

Transactions that undergo a due diligence process offer higher chances of success. Due diligence contributes to making informed decisions by enhancing the quality of information available to decision makers.

From a buyer’s perspective

Due diligence allows the buyer to feel more comfortable that his or her expectations regarding the transaction are correct. In mergers and acquisitions (M&A), purchasing a business without doing due diligence substantially increases the risk to the purchaser.

From a seller’s perspective

Due diligence is conducted to provide the purchaser with trust. However, due diligence may also benefit the seller, as going through the rigorous financial examination may, in fact, reveal that the fair market value of the seller’s company is more than what was initially thought to be the case. Therefore, it is not uncommon for sellers to prepare due diligence reports themselves prior to potential transactions.

Reasons For Due Diligence

There are several reasons why due diligence is conducted:

• To confirm and verify information that was brought up during the deal or investment process

• To identify potential defects in the deal or investment opportunity and thus avoid a bad business transaction

• To obtain information that would be useful in valuing the deal

• To make sure that the deal or investment opportunity complies with the investment or deal criteria

Costs of Due Diligence

The costs of undergoing a due diligence process depend on the scope and duration of the effort, which depends heavily on the complexity of the target company. Costs associated with due diligence are an easily justifiable expense compared to the risks associated with failing to conduct due diligence. Parties involved in the deal determine who bears the expense of due diligence. Both buyer and seller typically pay for their own team of investment bankers, accountants, attorneys, and other consulting personnel.