The Definition Of Due Diligence & Why Does It Matter

The Definition Of Due Diligence & Why Does It Matter

6-7 minutes

Due diligence, simply put, is the practice used to gather and process information—together, these would lead someone to make a responsible choice while staying on the right side of the law.

Due diligence is one of the most common processes conducted in a number of areas. Mostly, it is the finance people who are involved in this practice.

There are many aspects of due diligence that you may still be unaware of. Let''s dig in and come to know everything about it.

Here, You Will Find Out:

• What is Due Diligence in Business?
• Why Due Diligence is Important?
• Types of Due Diligence
• What is the Due Diligence Process?
• Common Errors in Due Diligence
• How Technology Can be of Help in Due Diligence?
• What Information is Included in a Due Diligence Report?

What is the Due Diligence in Business?

Due diligence, abbreviated as DD, is the assessment of financial, legal, economic, and tax-related complexities of a company before making any serious financial deal or a contract to start business in the market.

It goes beyond merely learning to collect some new facts and figures about an enterprise so you can make an intelligent business decision. It is a common activity performed by different commercial organizations when they are interested in fundraising, taking on a merger and acquisition, or any other financial ''big'' things.

Why Due Diligence is Important?

The fact remains that investors are doing aggressive due diligence of late. Amid the wild startup ecosystem, where BharatPe is accused of multiple wrongdoings, GoMechanic crash-landed, and Zilingo just vanished, investors are really using their DD muscle.

It''s worth mentioning here that DD isn''t a legal prerequisite. It''s a standard checklist which companies are recommended to do before they agree to go into business together.

These are performed in various sectors and for various purposes, some of which include:

• Mergers and Acquisitions (M&A)
• Income-producing property or land
• Investment and financing
• Intellectual property - the legal rights provided by the government to a person (or business) of their own properties or, in the case of publications, the right to own them; includes patents, copyrights, trademarks, and trade secrets
• Logistics management
• Regulatory compliance and risk management
• Cybersecurity - measures taken to protect computer systems, networks, and information from theft and damage to their hardware, software, or information, as well as fraud
• Human resources management
• Environmental, social, and corporate governance matters
• Business and microenterprise activities
• Government procurement contracts
• Franchise new business opportunities
• Cooperative agreements and partnerships

What Does the Due Diligence Process Entail?

Here''s what normal due diligence tends to focus on:

The Main Focus:

The fundamental business plan, the industry the startup is operating in, and who the competitors are. They''d also quiz you on market trends, and they''d look to put their finger on the proficiency of the team and skill sets and the vision of the founder.

The Inevitability of Risk:

Risk must be their prime concern—it is for any startup, especially in the initial stages. They will look to understand the level of risk of the business and, thereby, establish a business assessment, the remedial action to be taken to lower that level of risk, and the action already taken.

Product/Service Differentiation:

USP here stands for unique selling proposition of a startup product that differentiates it from and gives it a competitive edge over other products. VC diligence in this way involves studying a startup''s progress through an analysis of goods and services they have to offer, meeting potential customers, and evaluating a go-to-market strategy. The metric evaluates the legal rights of the new company to any intellectual property, including trademarks, copyrights, and patents.

Investors may further look into legal due diligence, financials, the possibility of an IPO, and how close the actual value is to the headline value when all assets and liabilities are calculated.

Due Diligence Pitfalls

If the balance tips too far towards one metric, this can become a problem. Investors might place too much emphasis on finances and not consider other integral details, such as whether the creator has been spending too much time on a concept to a venture without selling or if there are market elements that are uncertain, variable, or unknown.

How Can Technology Help with Due Diligence?

The main ways in which technology can help to facilitate the process of due diligence are as follows:

• Automated Data Gathering: With modern technology in place, this information could be aggregated using automation and technology that gleans information from various sources such as regulatory filings, financial reports, and even social media. Automation significantly facilitates the entire process and makes it more efficient relative to the traditional collection process.
• Data Analytics: One can use data analytics for unearthing trends, patterns, and even anomalies from large databases, which further helps in informed and enlightened decision-making for investors.
• Artificial Intelligence: Soon, there would be practical use of artificial intelligence tools that would review legal papers, such as agreements and patents, for signs of pitfalls and opportunities.

What is Typically Contained Within a Due Diligence Report?

The investigation of the company''s financial position, legal configuration, and business, with the added disclosure of any potential danger and opportunity arising from the investment/purchase.

Popular Terms