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What Is Due Diligence? (Meaning Explained)

Before making any financial decision, it’s essential to exercise due diligence – meaning an investigation performed to ensure it’s a worthwhile investment.

Of course, there’s always some risk involved when buying a business. However, a comprehensive due diligence check will help to identify any issues with the company before you commit.

In this guide, we’ll explain what due diligence is and why it’s an important part of the acquisitions process. We’ll also discuss how to conduct due diligence on a company you’re interested in.

What Is Due Diligence in Mergers and Acquisitions?

In mergers and acquisitions, “due diligence” refers to an in-depth review of the business you’re thinking of buying. Whether it’s an accountancy firm, beauty salon or software company, you’ll need to know the business is viable. This applies whether you’re a first-time buyer or expanding your existing portfolio.

Due diligence involves assessing every aspect of the company to confirm that it’s legally compliant, profitable, well-run and has good growth potential. Its aim is to help mitigate the risks associated with making a substantial business investment.

What Are the Types of Due Diligence?

There are three main types of due diligence:

  • Legal due diligence: this assesses the legal risks associated with the company, such as compliance with regulations, employment law and intellectual property.
  • Financial due diligence: this looks at the company’s financial health, including its accounts, profitability, tax position and debts.
  • Commercial due diligence: this assesses the company’s business model, target market, customers, suppliers and competitors.

All areas of due diligence are essential if you want to ensure you’re buying a profitable business. You’ll need to look into the company’s past, present and future – are there any unresolved litigation issues, for example? Are profits seasonal?

Why Is Due Diligence Important?

The consequences of not performing adequate due diligence before buying a business can be devastating. For example, failing to conduct legal due diligence means you may put yourself at risk of litigation. If the business isn’t following regulations or its permits have expired, you won’t be aware.

There could be financial implications, too.  Without financial and commercial due diligence, you could end up acquiring a failing business – one that’s leaking profits or has no solid place in the market.

How Is Due Diligence Conducted?

The due diligence process involves asking the seller questions and analysing documents and records pertaining to the business. This may occur in person with the business owner present, or through a cloud-based file sharing system. Some examples of documents that must be verified include:

  • Employee and payroll records
  • Licenses and permits
  • Insurance policies
  • Tax returns
  • Financial statements
  • Historical sales data
  • Details of any current or previous litigation
  • Intellectual property registrations and trademarks
  • Contracts with suppliers and partners
  • List of current customers and client agreements

Your advisers will put together a comprehensive due diligence checklist to ensure that nothing is missed.

When Should Due Diligence Be Carried Out?

Due diligence should be completed long before any contracts are signed. This will ensure that you have a full understanding of the business, its operations, its financial forecasts and any potential risks.

The due diligence process can broadly be split into two stages:

  • Phase 1 takes place before the seller has accepted an offer. It involves general research into the company, usually using publicly available information. It’s designed to identify any obvious issues with the business.
  • Phase 2 involves more in-depth analysis and generally happens after the buyer and seller have agreed on an initial deal. The buyer can request information from the seller and clarify any issues highlighted by the initial investigation.

Completing a due diligence check before the deal is finalised helps you make an informed decision. If it uncovers serious problems, you have the opportunity to negotiate your terms or walk away.

Who Is Responsible for Due Diligence?

While the seller must provide information when asked, it’s always the buyer who does due diligence during an acquisition.

Usually, the buyer works with a team of experts to carry out the review. This may include a solicitor, business broker, accountant or financial adviser. The entire process typically takes 1-6 months, depending upon various factors such as the size of the company.

Because of the expertise required and what’s at stake, you shouldn’t attempt due diligence without professional help. Contact a business acquisitions expert at Chelsea Corporate for advice.

Buying a Business? Chelsea Corporate Can Help

If you’re looking to buy a business, why not let Chelsea Corporate handle everything for you? We are buy-side business brokers committed to finding lucrative acquisition opportunities for our clients.

Our skilled team specialise in finding, vetting and approaching off-market businesses whose owners are looking to sell. With the help of our legal and financial experts, we’ll carry out comprehensive due diligence to ensure you’re getting a good deal.

Whether you’re based in the UK or overseas, Chelsea Corporate can help take the stress out of buying a business. Contact us today by filling in our enquiry form. Alternatively, call +44 (0) 20 3011 1373 or email info@chelseacorporate.com.