Due diligence
Due diligence is an investigation, audit, or review performed to confirm facts or details of a matter under consideration. In the financial world, due diligence requires an examination of financial records before entering into a proposed transaction with another party.
Due diligence is the process of examining the details of a transaction to make sure it’s legal, and to fully apprise both the buyer and seller of as many facts in the deal as possible. When the deal satisfies both aspects of due diligence, the two parties can finalize and correctly price the transaction. It’s a process of verifying, investigating, and auditing a potential deal or investment opportunity to corroborate facts, financial information, and other pertinent data.
People and organizations perform due diligence in many areas, including the sales of securities, IPOs, private equity funding, and real estate. Financial advisors commonly practice due diligence as well. The most widespread use, and the main topic of this article, is in mergers and acquisitions (M&A).
What Is Due Diligence in Business?
In business, due diligence is the process of making sure every aspect of a transaction is in order before it moves forward. When a company considers issuing an IPO, potential investors perform due diligence on that company to make sure it’s worth the investment. The term is sometimes used in the hiring process to verify that a candidate has the experience they claim.
Due diligence in M&A can include not only looking at obvious details like financial stability, sales, real estate, and intellectual property, but also pending litigation, labor relations, environmental problems, and relationships with third parties.
Why Due Diligence Is Important
- The process of due diligence serves numerous functions that benefit both buyers and sellers in a merger or acquisition. These benefits include the following:
- Allows a buyer to confirm financial, contract, customer, and other pertinent information about the seller
- Paints a fuller picture of the scope of the transaction, including discovery of previously unknown problems and assets
- Leads to more accurate pricing (the initial offer could rise or fall, depending on what due diligence uncovers) because decisions are better informed
- Permits the buyer to back out of a deal if due diligence uncovers problems that are too big or complex to address
- Creates greater awareness, clearer expectations, and increased comfort for the buyer and seller of what’s expected of them to close the deal
- Reduces the knowledge gap between buyer and seller, leading to better (and better-informed) decisions
How Long Does Due Diligence Take?
While the LOI will delineate a time frame for due diligence, the general consensus is 30-60 days, but each merger or acquisition is different. Due diligence might run longer or shorter; the benchmark time frame exists to ensure that the due diligence process doesn’t become a sprawling, unending monster with no end in sight.
Consider the following when setting a timeline:
- The complexity of the deal (e.g., how many subsidiaries does the acquired company have?)
- What business (industry and vertical) is the acquired company in?
- How large is the target company?
- What kind of merger or acquisition is it
- Are any international properties involved in the deal?
- The legal portion of the process can take 10-20 percent of your time and effort, and other portions take up the remaining 80-90 percent.