Due diligence is the process of investigation and analysis a business or individual conducts prior to entering into any transaction, like investing in an investment. Due diligence is required by law for businesses that wish to purchase other assets or businesses. It is also required by brokers to make sure their customers are fully aware prior to approving the transaction.
Investors typically conduct due diligence when looking at potential investments, that could include a corporate acquisition such as a merger, divestiture or merger. Due diligence can uncover hidden liabilities, for instance legal disputes or outstanding debts that could be disclosed only after the fact, and could affect the decision to conclude the deal.
Due diligence can be classified into three categories: financial, commercial fiscal, and tax due diligence. Commercial due diligence is focused on a company’s supply chain and its market analysis and its growth prospects. Financial due diligence review examines a company’s financial books to ensure that there aren’t any accounting irregularities, and that the company is on solid financial footing. Tax due diligence analyses a company’s tax exposure and also identifies any tax owed.
Most of the time, due diligence is limited to a time frame that is negotiated, called the due diligence period, where buyers can assess the purchase and ask questions. Depending on the type of deal, a buyer could require the assistance of a specialist to conduct this investigation. A due diligence on environmental issues could include an inventory of environmental permits and licenses that are held by a firm, while due diligence on financial matters may require an audit conducted by certified public accounting firms.