Due diligence

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Due diligence is a term used for a number of concepts involving either the performance of an investigation of a business or person, or the performance of an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations. In particular, due diligence is a process through which a potential acquirer evaluates a target company for acquisition.^[1]

1 Investigative due diligence
2 Due diligence as a concept in civil litigation
3 Due diligence as a criminal defense
4 See also
- 4.1 External Resources
5 References

[edit] Investigative due diligence

[edit] Uses of due diligence

In finance, due diligence is the process of research and analysis that takes place in advance of an acquisition, investment, business partnership or bank loan in order to determine the value of the subject of the due diligence or whether there are any "'skeletons in the closet'".

The potential investor generally uses in-house resources or hires a consulting firm that specializes in due diligence and corporate investigations to investigate the background and principals of the target company. Professional reports from accountants and solicitors will also frequently be included.

Due diligence can also refer to the ongoing activities of pension or investment fund managers in keeping track of the operations, solvency, and trustworthiness of the managers of a corporation in which their fund is invested, or those of the managers of an acquiring corporation toward a target corporation.

[edit] Differing concepts of due diligence

In the US, the key factor that separates due diligence from a more in-depth background check is that due diligence reports are always gathered from publicly available information. A due diligence assignment generally includes reviewing press and SEC filings, checking for regulatory and licensing problems, identifying liens and judgments, and uncovering civil and criminal litigation matters. Sophisticated investigators will also search for conflicts of interest, insider trading and press and public records that identify problems that may have occurred under the principal's "watch." Public records often include sensitive data on a target, such as their date of birth and social security number, which can be gathered from credit card records. Unlike a background check, more intrusive methods of surveillance are not used.

By contrast, due diligence in the UK can and frequently does mean an examination of the target's private records, such as the internal audit reports of a company and important contracts. This clearly requires the consent of the company that is the subject of the due diligence, as would be the case for a recommended takeover offer, a private acquisition or a bank loan. Because the investigators have access to sensitive information, the due diligence process is covered by confidentiality undertakings.

Due diligence is also frequently conducted into the probity of sales agents, consultants and distributors, or companies for merger, acquisition or joint venture, to ensure that potential business partners do not carry any liability of bribery and corruption.

In lay terms, due diligence is the responsibility one has to investigate and identify issues, and due care is doing something about the findings from due diligence.

[edit] Due diligence reports

The investigative results may be prepared in a "due diligence report" that collates the information uncovered during the due diligence in an orderly way that allows an analysis of the nature of the target and the risks involved in involvement with it. For example, the report on the target of an acquisition will, so far as possible, contain an analysis of the company's financial situation and prospects (including its assets), its contractual relationships with clients and suppliers, its legal risks, its tax position, its employees, its IT systems and anything else relevant to its particular industry.

[edit] The purpose of investigative due diligence

The overriding purpose of this form of due diligence is to allow the investigating party to find out everything that it needs to know about the subject of the due diligence. This then allows the investigator to consider his options in light of the facts:

Withdrawal from the deal - if the due diligence unearths information that makes the investment, loan or participation risky or undesirable and which cannot be adequately resolved then
Adjust the valuation of the investment - the investigator may revise his valuation of the company or reassess the price at which it will provide services. Usually the information will be adverse and therefore the valuation will go down or the price will go up, as positive information will have been made more publicly available by the target from the start.
Have the problem remedied - it may be possible for a problem uncovered by the due diligence to be remedied before the deal goes ahead. For example, unpaid stamp duty could be paid, company filings could be put in order or, if negative information is uncovered on a principal of the target company, the investor may put pressure on the target firm to replace that individual. This will mean that the target is put into a state that the investigator is happier with before it deals with it.

[edit] Due diligence in real estate

In US real estate law, due dilligence may be a legal requirement. It is usually conducted by preparation of a Phase I Environmental Site Assessment on a real property holding, which is performed to determine potential environmental conditions that may cause harm to the surrounding environment.

[edit] Due diligence as a concept in civil litigation

Due diligence in civil litigation (also known as due care) is the effort made by an ordinarily prudent or reasonable party to avoid harm to another party. Failure to make this effort may be considered negligence. This is conceptually distinct from investigative due diligence, involving a general obligation to meet a standard of behaviour. Quite often a contract will specify that a party is required to provide due diligence.

[edit] Due diligence as a criminal defense

In criminal law, due diligence is the only available defense to a crime that is one of strict liability (i.e. a crime that only requires an actus reus and no mens rea). Once the criminal offense is proven, the defendant must prove on the balance of probabilities that they did everything possible to prevent the act from happening. It is not enough that they took the normal standard of care in their industry - they must show that they took every reasonable precaution.