Due Diligence: definition and purpose
Definition
Due diligence, a term often mentioned in relation to acquisitions or sales of businesses, literally means “due diligence” in English, emphasizing the care and confidentiality with which it must be conducted.
Today, the term due diligence is used to identify the investigative process undertaken to analyze the value and conditions of a company — a detailed analysis of the business and its reputation aimed at determining the suitability of an investment, merger, acquisition, or any commercial relationship.
Purpose of conducting due diligence
What is the objective of performing due diligence in the context of acquiring or selling a small or medium-sized business?
The purpose of due diligence is to assess the opportunity and feasibility of the transaction, determine the fair value of the company, and verify if there are any critical issues that could jeopardize the success of the deal.
For this reason, the scope of due diligence is very broad and covers all information related to the business being acquired, with particular attention to the following aspects:
- corporate and organizational structure
- business and target market
- guarantees and contractual conditions
- commercial strategies
- management and administrative procedures
- economic and financial data
- tax and legal matters
- potential risks
Due diligence: timelines and different types
Timelines of the due diligence process
Many wonder what the average duration of due diligence is. The truth is that it varies widely depending on the amount of information to be analyzed, the depth of verification and analysis activities, and any difficulties encountered by those conducting the process in obtaining the necessary data.
Generally, for small or medium-sized operations, due diligence lasts between 3 and 16 weeks (longer for larger and more complex transactions).
Types of due diligence
The most common types of due diligence, which are sometimes combined, include:
- Commercial due diligence: a detailed analysis of the company’s commercial aspects, assessing organizational structure, market position, and commercial potential.
- Accounting and tax due diligence: examines the company’s accounting and tax situation by analyzing financial statements and income statements, verifying compliance with civil and tax laws, checking the regularity of accounting books and VAT records, income tax returns, and any tax audits conducted by authorities.
- Operational due diligence: reviews the efficiency and effectiveness of company operations, including business processes, supply chains, supplier and customer relationships, and human resources matters.
- Legal due diligence: aims to gather and evaluate key information about the company’s active and passive legal situations (rights, obligations, liabilities, etc.) and identify any critical issues.
- Real estate due diligence: involves assessing the condition of property or real estate assets before any potential ownership transfer.
- Financial due diligence: offers a detailed financial analysis focusing on revenues and profit margins, examining any financial debt and adjustments that may have been made to present a better financial position than actual. This includes studying all assets and liabilities, working capital, capitalizations, investments, and cash flow to provide a comprehensive picture of the company’s financial health.
Conclusion
In conclusion, due diligence is an essential and delicate process when buying a company. It is the crucial step that allows you to dig deep and gain a clear understanding of what you are about to purchase.
However, it is also a complex process requiring experience and expertise. Therefore, while you can do much research on your own, it’s always wise to involve experts in the field. A legal consultant specialized in business acquisitions, an accountant, and a financial advisor can help you navigate the complexities of due diligence, protect your interests, and ensure everything is in order.
