Due Diligence is a preliminary step in the acquisition or investment in a company including during M&A deals. Different types, pros and cons… we take stock.
Due Diligence : definition
The due diligence process especially meets all the checks carried out by a potential buyer or investor before a transaction in order to project themselves more easily on the situation of a company.
Originally, the term due diligence is an Anglo-Saxon concept of commercial and private law. It involves all the stages of risk assessment. Thus, whether for the acquisition of real estate or a company and before investments and IPOs, buyers go through this Due Diligence by analyzing its strengths and weaknesses in order to assess the value of the offer. Before entering into a contract, due diligence requires knowing exactly what it is.
What are the different types of due diligence ?
There are different types of due diligence, namely :
Financial audit
One of the most common types is financial auditing. As part of the financial audit, it involves checking whether the financial data is correct and analyzing the accounting data (balance sheet, income statement, etc.). The aim is to understand overall financial performance and stability and to find any other underlying issues. Items audited may include :
- Financial statements
- The company’s forecasts and projections
- The inventory tables.
> To learn more about financial audits, click here
Legal audit
The legal due diligence makes it possible to determine whether the target company is subject to legal constraints or whether it is affected by problems. Items assessed include :
- Contracts
- Company documents
- Verbatim records from meetings of the Management board
- Compliance theory
Human resources audit
The human resources (HR) due diligence focuses on the most critical asset of the company: its employees. The HR audit aims to understand :
- The organizational structure of the company
- Salary and benefits
- Job openings
- Union contracts (if any)
- Any type of harassment or wrongful dismissal.
Operational audit
Operational due diligence involves a review of all the elements of a company’s operations. The aim is to assess the condition of technology, assets and facilities and to identify any hidden risks or liabilities.
Environmental audit
Environmental due diligence assesses that the company’s processes, equipment and facilities comply with environmental regulations. The aim is to rule out potential penalties in the long term. These can range from small fines to more severe penalties such as a factory closure.
Business audit
Business due diligence is used to identify the customers of the company and its industry. It helps forecast the impact and associated risks that the transaction may have on the existing customers of the acquiring firm.
Strategic adjustment
The strategic adjustment due diligence assesses whether the target company is appropriate to its goals and objectives. For this to happen, the buyer must assess :
- Potential synergies
- The advantages of deals
- The efficiency of the merger between the two entities
Self-assessment
Self-assessment due diligence is often overlooked by companies. It is yet one of the most important. It must be implemented as soon as an investment or integration is considered.
Due diligence examples
Below, you can find several examples of the use of Due Diligence :
- Before buying a property, conduct thorough inspections to make sure it is a good investment
- A subscriber who checks the activities and operations of an issuer before selling it
- A company that reviews another to determine if it is a good investment before proceeding with a merger
- Consumers who read online reviews before purchasing an item or service
- People frequently checking their bank accounts and credit cards to make sure there is no unusual activity
- An employer inquiring about an applicant before making a job offer to make sure that he meets the criteria
- A person testing a product in store before buying it
Due diligence : pros and cons
No matter your profile, whether you are a private individual or the CEO of a large company, at some point you will need to invest to carry out your projects. However, corruption, money laundering or tax evasion are risks that should be considered before negotiating a price. If you invest in real estate, the risk of money laundering is high.
The due diligence process is also recommended to check whether there is a question of gray market, where there is little government control. In general, small businesses or startups are less prone to these kinds of risks. However, relying on due diligence is essential to protect the beneficial owners from potential legal consequences and to minimize the risks.
How much due diligence is ?
The price of due diligence varies depending on the type of audit you choose, however, it is expensive for a small business that cannot afford to invest in it. It is often offset by the future savings and generally allows the buyer to reduce his acquisition costs and request an extended liability guarantee.
To conclude, Due Diligence is not just about the accounting and financial analysis of a company. There are many factors to consider, which is why it is essential to surround yourself with professional accountants to advise you.
This is why we recommend that you refer to one of our chartered accountants at CF Henderson, who will be able to offer you tailored solutions. Our expertise allows us to rightly support you, and to help you create, develop, transform or pass on your structure with confidence.
With CF Henderson you will find the answers to your questions.