What Is Due Diligence?
Due diligence is the process of gathering various types of information about a company that may be acquired, merged with, or partnered with another organization. In this article we will provide you the types of Due Diligence.
This information involves accounting, equity, legal issues, processes, activities, technology, human resources , future perspectives and much more.
The result of this process will inform the decision-making : based on what was gathered, is it worth closing the deal? Are the values posted fair?
This is serious work, which must be done rigorously and by specialized professionals, without skipping steps.
But be careful not to confuse it with auditing , a process whose focus is usually on compliance with regulations and laws – therefore, it has a different scope than due diligence.
In Portuguese, the equivalent term is due diligence.
Diligence, in this case, refers us to the term used by the Civil Police in investigative operations with thorough search, research and investigation.
The previous word is applied because the process takes place before the deal is closed . In other words, the company’s situation is investigated so that a decision can be taken later.
The most common, however, is the use of the term in English, whose literal meaning is a little different, since due means suitable, due, convenient, fair.
Whatever the term used, it is important to emphasize that the investigation of the due diligence in question is neither forced nor carried out in secret.
In order for the due diligence to be carried out correctly, those in charge must have access to a series of documents that contain the desired information.
What Is Risk Due Diligence For?
When an administrator wants to grow his business , he has several paths to follow.
One of them is to explore a new market, acquiring a company that already has all the know-how in the area, in addition to a brand known by the consumer public.
Acquiring another company that operates in exactly the same area can also serve the purpose of growth.
In this case, customers are inherited and production capacity is increased, not to mention the learning generated by contacting the former competitor’s processes .
A similar logic occurs in the merger, when the two organizations form a partnership , as both perceive the same benefit when joining forces.
Even if there is no purchase or partnership, two companies can also work together through a partnership signed by signing a contract.
And what does all this have to do with the due diligence process?
In each of the operations we just talked about, the final terms , such as prices and guarantees, will depend on a lot of study.
Due diligence is used so that those in charge of making the decision regarding the operation have elements to assess whether the purchase, merger or partnership is really worth it.
In addition to finances, the legal risks of the business are analyzed .
Based on the results of the due diligence, managers decide whether to continue or withdraw from the operation.
How Does it Work?
First of all, it is necessary to assemble the team that will be responsible for the due diligence process.
A good alternative is to hire the service of companies that specialize in this type of audit – and therefore already have a scope of work model.
If the idea is to assemble this team internally, bet on experienced professionals and look for multidisciplinarity , such as administrators, accountants, lawyers and other specializations that you deem appropriate.
The first stage of the work is an initial observation, in which the characteristics of the scenario to be evaluated are identified.
From there, the best work strategy to be adopted in that environment will be defined.
This initial step also serves for the team of auditors to build a relationship with the employees of the analyzed company.
Due diligence actually begins when professionals begin to analyze the various documents that contain the information that will support the decision-making process.
This includes the articles of association, accounting files, spreadsheets, minutes of meetings, information on assets and liabilities and various other documents relating to the company’s activity.
This analysis step may also include consultation with public bodies or even other companies that have a contract with the one being analyzed.
In short: a lot of information is collected for the starting point and it should be so for the result to be as detailed as possible.
The final step consists of the production of a final report by the team responsible for the due diligence.
It should list the main problems and risks encountered. Even better if you already include suggestions for strategies to solve or minimize them.
How Important Is Due Diligence In The VUCA Era?
The term VUCA was created by the United States Army War College, a teaching institution of the United States Army.
It was proposed to describe the increasingly unpredictable dynamics of world geopolitics after the Cold War and began to be talked about more in 2001.
To say the world is VUCA means it is:
- V , from volatile (volatility)
- U , from uncertain (uncertainty)
- C , from complex (complexity)
- A , from ambiguity (ambiguity)
Just by reading and thinking in these terms, it is already easy to understand why the term VUCA is widely used in business administration today, isn’t it?
More than ever, organizations need to quickly adapt to change , be flexible and resilient.
Because technology causes profound changes in consumer behavior and globalization brings competition from the entire planet to any sector of the economy.
On the one hand, there is little room for error. On the other hand, there are fewer certainties and more volatility.
In this context, you need to arm yourself with as much information as possible when making important decisions .
Therefore, practices such as due diligence are mandatory in large operations involving two companies – after all, the current moment does not allow adventures guided only by intuition.
Types Of Due Diligence
Below are the types of Due Diligence.
There are several possible focuses on the due diligence process. Next, we will present some of the main ones.
It is important to understand that one does not exclude the other . That is, the same due diligence can aggregate several of the types listed below.
Due Diligence Compliance
Compliance is a term used to refer to compliance with laws , resolutions and other legal determinations, in addition to internal rules.
To be in compliance, therefore, is to be in agreement with all this.
In the case of compliance-focused due diligence, we are referring to a process that investigates whether the analyzed company is in this condition .
Does she commit fraud? Does it not obey a certain legal determination? Does it violate its own internal rules?
These are questions that due diligence compliance seeks to answer.
Integrity Due Diligence
This is a model of due diligence created by Petrobras to fight corruption in the company.
The Integrity Due Diligence (DDI) focuses on contracting goods and services and on the relationship with suppliers.
The DDI is a procedure that takes place with the analysis of detailed information from possible partner companies, such as organizational structure, integrity history, relationship with public agents and others.
This procedure results in the attribution of an Integrity Risk Degree (GRI) to each evaluated company.
Environmental Due Diligence
Environmental due diligence analyzes the possible risks to the environment related to a particular company.
It may also involve analyzing the conditions of a particular region, if there is a plan to install an industrial unit there or exploit its resources, for example.
In this case, the process would investigate whether the activity would pose risks of contamination of springs, damage to the local fauna and flora and other damage to nature.
As it is a very specific type, environmental due diligence should involve specialized professionals , such as lawyers with knowledge in environmental law , biologists and geographers.
Financial Due Diligence
The financial due diligence analysis focuses on the company’s income, expenses and equity .
What is your earning potential and your cash flow? What are your assets, liabilities, debts and administrative and maintenance costs?
It is also very important to have a macro view and understand that negative numbers in this analysis are not conclusive.
After all, they can hide great opportunities that can sometimes be taken advantage of with simple adjustments to the company’s financial management .
Accounting Due Diligence
Do not confuse the financial analysis that we explained in the previous topic with accounting due diligence.
Here, the focus is on the taxes levied on the activities that the analyzed company carries out, and the main object of analysis is its tax documents .
This assessment should be based on the current scenario and also considering future perspectives.
Ideally, accounting due diligence should be performed by professionals specializing in the applicable jurisdictions and tax code .
Technological Due Diligence
For a company to grow, even if its final product or service is not technological at all , it invariably needs to take advantage of many of the technological solutions available in the Information Age .
When an administrator thinks about acquiring a company, therefore, he must assess the conditions of the information technology (IT) structure .
This goes far beyond the hardware collection: software licenses used, systems security , integration between databases and processes – all of this is relevant.
Intellectual Property Due Diligence
Intellectual property is a legal protection over a creation , preventing competitors from appropriating a company’s intangible assets.
Contrary to what some people think, not all intellectual property rights are automatically transferred when a company is acquired.
It is important that intellectual property due diligence is conducted by a professional with knowledge of the field, who will analyze which brands, patents, copyrights and other intellectual property are included in the deal .
Labor Due Diligence
Labor due diligence is done to identify possible weaknesses and labor risks in a company.
This includes not only current employment processes but also hiring practices and regimes that pose future process risks.
This type of due diligence must be conducted by lawyers specialized in the area, who will analyze employment contracts and seek from the human resources sector and managers all types of information relevant to this assessment.
Real Estate Due Diligence
This is a type of due diligence that can be done when the business is simply purchasing a property .
In this case, the process is conducted by professionals specialized in real estate law , who will work to reduce the risks of the operation.
This includes in-depth analysis of all types of documentation involving that property and investigation to find out if there are any legal or administrative proceedings related to it.
Legal Due Diligence
It is the process carried out by competent lawyers, who analyze all the legal liabilities of the company being evaluated.
This includes the commercial, tax, labor, social security , corporate areas, in short, any sector in which there may be a legal liability.
The risks are also evaluated, that is, what are the current conducts of the company that can generate new liabilities of this order.
Note that some legal due diligence functions are also assumed in other categories that we are talking about here, such as compliance due diligence.
Valuation Due Diligence
Finally, we cannot fail to highlight the importance of due diligence in the valuation process , that is, the evaluation of the price of the company that is to be acquired or incorporated.
Based on all the analyzes described in the previous topics, the due diligence will allow better conditions to know if the value placed in the business is in line with the company’s reality.
When To Carry Out The Due Diligence Process?
As we explained earlier, it is recommended that you conduct a due diligence process prior to purchasing, merging, or major partnership with another company.
Don’t be fooled by the value of the acquisition: even if it’s a purchase that doesn’t compromise your company’s finances, it can inherit liabilities such as debts and labor lawsuits.
But due diligence can be good even when there is no such plan, involving business with another organization.
In this case, it would work as an internal audit , an analysis with the purpose of helping managers to have a broad and at the same time detailed view of various aspects of the company.
This healthy practice helps in understanding issues such as:
- Positioning of the company in the market: in the face of direct and indirect competitors, how is its performance?
- Expectations for the future: considering the company’s numbers and consumption trends for the future, what is expected of the company?
- Accounting and tax situation: are the finances organized and controlled? Is tax management done competently or are there risks in this area?
- Threats and weaknesses: what are the company’s weaknesses and what internal or external elements threaten its health in the short, medium and long term?
If you want to know the answers to these kinds of questions about your company, it’s worth conducting due diligence at any time. We hope that you have understood the types of Due Diligence.
