Types of Due Diligence

Due diligence refers to the investigation and analysis a business or individual conducts prior into any transaction, like investing in the business. This investigation is generally required by law for businesses seeking to buy other businesses or assets and by brokers who want to ensure that the client is fully informed of the details of a transaction prior to signing a contract.

Investors usually conduct due diligence when evaluating investments which may include an acquisition either through merger or divestiture. Due diligence can uncover undiscovered liabilities, like outstanding debts and legal disputes, which would only be disclosed after the fact. This could affect a decision on whether to close a transaction.

Due diligence can be divided into three categories: financial, commercial fiscal, and tax due diligence. Commercial due diligence focuses on a company’s supply chain, market analysis and growth prospects, while a financial due diligence analysis examines the company’s financial records to make sure there aren’t any accounting irregularities and that it is on solid financial footing. Tax due diligence studies the tax exposure of a company and identifies any outstanding tax.

Usually due diligence is restricted to a specified timeframe, called the due diligence period, during which buyers can examine the potential purchase and ask questions. Depending on the type of deal one might require expert assistance to conduct this investigation. A due diligence on environmental issues might include an inventory of environmental permits and licenses issued by a business, while due diligence on financial matters might involve an audit by certified public accounting firms.

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