Due Diligence: what is it and what you need to consider

Due diligence is a term that gets thrown around a lot. It's a concept in law that means an investigation or audit of a potential investment, partnership or acquisition.

The Blackroom Team
The Blackroom Team

Due diligence is a term that gets thrown around a lot. It's a concept in law that means an investigation or audit of a potential investment, partnership or acquisition. Due diligence makes it possible to answer any questions that the buyer or potential investor may have before the purchase. It allows them to gather as much information as possible and to carry out a complete assessment of the value chain, the potential risks and the opportunities of the company concerned in order to ensure that the transaction is viable.

Depending on the countries, due diligence is not mandatory and therefore can be done at various stages during an acquisition process: pre-acquisition, post-acquisition (or post-due diligence), expansionary and consultative due diligence. In each scenario there are different types of due diligence involved depending on the current stage and what information is needed at hand for the decision making process.

Financial due diligence

Financial due diligence is the process used to determine whether a company has the financial foundation to support an investment. It's important for both potential buyers and investors.

In order to make an informed decision about whether or not to go through with buying your brand, your potential buyer will want to verify all of its financial information first. Financial due diligence can help you understand the financial viability of your investment by scrutinizing its history and operations through analysis, interviews, site visits and a review of any underlying documentation that might have been collected during this phase in particular.

Legal due diligence

Legal due diligence is a process undertaken by the buyer’s legal team to ensure that the deal meets all legal requirements. This includes researching any pending lawsuits against or involving your target company, as well as its corporate structure and ownership.

If you're buying a business, it's important to understand who owns it and what their rights are under applicable law. You also need to know if there are any pending lawsuits against or involving your target company so that you can protect yourself from future liability.

Tax due diligence

Tax due diligence is the process of finding out about all tax obligations associated with a business transaction, including past, current and future taxes. Tax due diligence can be done by either the buyer or seller using their own lawyers and accountants, or through an accounting firm brought in by the buyer or seller.

What does tax due diligence involve?

Operational due diligence

Operational due diligence involves looking at the internal structure of a company that’s being considered for purchase or investment and evaluating its operations to determine if it would be able to meet future performance expectations. Operational Due Diligence looks at things like the business strategy, products and services, quality control systems and how the company manages risk.

The purpose of commercial due diligence is to examine whether a company is viable from a financial, technical and commercial point of view. It is based on an in-depth analysis of the company's products and services, markets, customers and distribution channels, as well as its ability to manage price, volume and mix risks

Commercial due diligence

Commercial due diligence (CDD) is a report that helps you evaluate the health and sustainability of your potential acquisition. It's a comprehensive assessment of the organization's revenue, profitability, competitive position and growth strategy. In other words, it provides clear paths to capture additional revenue during the post-acquisition phase and confirm that the market and commercial dynamics underlying expected synergies and strategic rationale are realistic.

The objective of the Commercial Due Diligence is to provide an independent assessment of:

  • The quality, financial performance, growth prospects and risks associated with an acquired company
  • Key assumptions regarding pricing power, customer retention rates or cost savings within existing contracts or customer relationships

Human Resources due diligence

HR due diligence is the process through which a company acquiring another analyzes the employees within the company and the policies and procedures that affect them. Engaging in due diligence can help a company avoid losing its talent after securing an acquisition deal. Understanding more about HR due diligence can increase your knowledge of the acquisition process and help you learn how to investigate a company's human resources properly.

The HR due diligence report outlines key issues related to employee benefits, compensation programs, retirement plans, workplace diversity initiatives and other aspects of employment law compliance—but it doesn't cover every little thing that could be considered "human resources." For example: An employer may have an excellent 401(k) plan for its employees with matching funds from their own contributions—but does it include any third-party investments? If so, what kind of fees do they charge? Are there any hidden ones? During this step of acquisition planning and negotiation processes will depend on answers to questions like this one because those details are key components for determining if there's enough money available for everyone involved.

HR due diligence will also give you clues on your target’s cultural values. Culture is often one of the major pitfalls when it comes to M&A success. Assessing early in the process the differences between your own company’s culture and your target’s will help you determine what’s the right path to choose if your acquisition thesis is full integration.

ESG due diligence

ESG (Environnemental, Social and Governance) due diligence is an integral part of any merger and acquisition (M&A) transaction, especially in the last years. ESG considerations are becoming an increasingly important part of doing business — and that includes the due diligence process for mergers and acquisitions. ESG due diligence in today’s world is all about helping the buyer understand whether the target company meets its stated ESG criteria and does not pose a reputational risk to the business.

Intellectual Property due diligence

IP due diligence is a key part of the overall due diligence process for most transactions, especially when they involve a tech company. It can include:

  • The purchase of a business with intellectual property (IP) or technology;
  • A sale of IP (such as an assignment in connection with an exit strategy); and/or
  • An investment into a start-up company that includes IP.

Conclusion

When you consider all the different kinds of due diligence, it's easy to see how important this process is. The more information you have, the more likely you are to make a good decision and avoid costly mistakes. This means that it's worth your time and effort to get good at identifying what kind of due diligence is necessary for any given situation.

As a final thought, a good way to simplify this complex process is to start building an efficient data room early in your startup growth journey. With this highly secure application, you will be able to index your folders and documents in it, and share them with the right people. 

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