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After investing in and sowing your new business, do you now plan to get your startup funded? But wait, are you even ready to survive through the due diligence process?
You have set up a business with high growth potential and within no time, orders have started pouring in, there is a steady stream of new customers and your startup is finally making a profit every month. With all this in hand, investors approach you for a merger or even an acquisition. Seems like you have achieved all that you have been struggling for? Probably, not yet.
The due diligence is a process that not everyone talks about. You will come across tons of content on growing a business, making money and pitching investors. But unfortunately, no one really talks about due diligence.
What is Due Diligence?
Due diligence is a process where an acquiring firm investigates and assesses the target entity’s business, operations, compliances and financial performance. The review is conducted to gain confidence from the business deal. It saves both parties from unnecessary issues that may arise later. With a little homework at the initial stage, the acquiring company will be thoroughly satisfied with the decision before entering into a legally binding contract.
What are the different types of Due Diligence?
There are various types of due diligence that provide companies insight and knowledge of their prospective business transaction. While exploring the true value of the prospective deal, you save your entity from the possible harm caused by an ill-informed decision.
The different types of due diligence exercised are according to the situation, intent and requirements. Due diligence can be carried out by the entity to closely evaluate the strengths and weaknesses of the target legal entity. While some may carry out due diligence to gain valuable information that enables companies to understand the true cost of the business transaction.
Let’s take a look at how a company can conduct due diligence on various events:
Merger and Acquisition
Merger and acquisition, famously known as M&A is a type of due diligence which is conducted when two entities join together to form one consolidated company, or when one company purchases all or a portion of the target company’s assets and liabilities. M&A due diligence enables the buyer to determine how the prospective deal of merger or acquisition will turn out in the future.
With M&A due diligence in place, the buyer understands the potential risks and rewards associated with the target company. This, in turn, allows the company to plan for the integration of the target entity with greater visibility.
Financial Due Diligence
When a company targets to acquire an entity or an asset that is up for sale, the accurate value of the prospective deal is what they are mostly concerned about.
Financial due diligence has an answer to such concerns. This is a procedure that allows you to assess the financial stability and health of the assets up for sale or the targeted entity. In financial due diligence, the prospective buyer scrutinizes financial data of the company and possible areas of risk are identified.
The main aim of financial due diligence is to acquire relevant information concerning the historical and actual financial health of the company. The approach pulls patterns from the data and allows you to forecast the future performance of the company or the targeted asset.
Customer due diligence
Customer due diligence, also known as CDD, is the process to know your customers more deeply by assessing their risk profile. It is an investigation through which relevant information about the prospective customer is gathered and evaluated for any illegal involvement in practices such as money laundering or terrorist activities.
When a company undertakes the process of customer due diligence, they reduce the risk of fraud that could have arisen by conducting businesses with an illegal customer. When you know your customers and their activities closely, you can confidently build healthy relationships with them. The level of customer due diligence required depends on the business deal, size and type of the customer.
Commercial due diligence
Buying a business can be a risky step. What may seem attractive initially may not turn out after the acquirer takes full control. This is why commercial due diligence is an extremely important step that helps acquirers minimize the risk and reap maximum benefits.
Commercial due diligence is an assessment of the target company’s internal and external environment, unlike financial due diligence that only focuses on the financial aspect of the entity. It provides buyers with information about the targeted company’s commercial position, market demand and competitor’s performance. The process also allows entities to determine whether the acquisition is likely to yield the expected profits and be successful commercially in the long run.
Vendor Due Diligence
Vendor due diligence is the process conducted by a private entity that is either being sold or has assets up for sale. The process is undertaken upon the request of the seller and is usually managed by external experts. The third-party experts carry out due diligence audits to determine the financial stability and prospects of the company being sold. The report then becomes available to potential investors that assist them to make a wise and informed decision.
Third-Party due diligence
Companies conduct third-party due diligence to collect relevant information about the potential vendor’s reputation, business structure, ownership and activities. This process allows companies to understand the level of risk which may be involved by outsourcing work to an external third-party.
Third-party due diligence helps businesses to establish a clear picture of who their vendors are. The process also gives an idea of whether the potential vendor is capable of delivering the products or services that match the needs of the company.
This type of due diligence has been gaining popularity since the recent years after the introduction of strict anti-bribery legislation. As companies are now required to ensure their business has sufficient anti-bribery measures in place.
Secrets to effective due diligence
When it comes to the well-being of your company, it is important to understand that the companies you aim to do business with are credible. The history is full of instances where companies have either been shut down or had to bear heavy penalties after being associated with negative third-parties.
Whether you are aiming for an acquisition or buying services from a third-party, an in-depth examination of the prospective business transaction is extremely crucial to identify any possible risk.
An effective diligence process requires systematic efforts from start to end. Let’s talk about how it should be carried out efficiently.
Due diligence is a lengthy and complicated process and it is important to allocate sufficient time on the exercise to ensure all uncertainties are thoroughly explored. A well-designed due diligence plan with a proper time frame will help to evaluate each area closely and identify the possible threats and hidden costs.
Due diligence checklist
With a due diligence checklist, an entity will not only have an idea of what they are supposed to do but a checklist will help keep the progress in perspective. A comprehensive checklist can cover different aspects of the business such as legal and tax matters, financials and sales, assets, liabilities and debts and operational expenses.
The due diligence process becomes smoother and convenient when the assistance of an expert is taken. Since they are the experts in this subject matter, they will conduct consistent and enhanced due diligence checks to ensure all untapped areas are thoroughly examined and evaluated. If you want to do your due diligence using the right and smart approach then there is no better way then seeking an expert’s assistance.
The Bottom Line
The hard truth is due diligence can be time-consuming, complicated and tedious but it would be safe to say that the process can save you from making a wrong decision.
Without conducting the necessary checks and due diligence, you may enter into a business transaction involving significant risks and threats. With the due diligence process in place, you will be ensured that all relevant precautions are taken before negotiating a business deal.
An organized due diligence plan will assist you to ascertain the true value of the target entity. Also, it will help the business to stay compliant concerning anti-bribery laws and anti-money laundering regulations.