‘It is important that organisations do their due diligence.’ This is a phrase everyone has heard said at some point. It may even be a phrase you have said. But, what does it mean exactly?
Define “Due Diligence”:
The Oxford English Dictionary defines due diligence as “law appropriate, sufficient, or proper care and attention, especially as exercised to avoid committing an offence”. Or in business terms, “a comprehensive appraisal of a business undertaken by or on behalf of a prospective buyer, especially in order to establish the exact scope of current assets and liabilities, and to evaluate future commercial potential.”
What does “due diligence” mean in practice:
Sometimes, just defining a word does not make the concept any easier to grasp. The purpose of due diligence is to ensure financial stability when taking risks in business, especially in mergers and acquisitions. Due diligence works by an organisation, department, project, or person undergoing an investigation, an audit, or a review. Have you ever performed a performance review? If so, then you have already done due diligence!
In practice, there are two types of due diligence. Hard due diligence and soft due diligence.
What is Hard Due Diligence:
Hard diligence is based upon, but not limited to, a financial review. The aim of this is to understand the financial obligations that an organisation has. Hard diligence items that should be on your due diligence checklist include:
- Financial due diligence — This is to gain an understanding of the financial performance of an organisation. This can be done through an audit of the financial statements, the organisation’s forecasts and projections, the inventory schedules, etc. This must be done to confirm the accuracy of the financial records in the Confidentiality Information Memorandum (CIM).
- Legal due diligence — This is to determine if the organisation is involved in any legal complications, including current or potential court cases or lawsuits. Therefore, any contracts, corporate documents, meeting minutes (especially the board’s) or compliance doctrines need to be assessed to complete the due diligence process.
- Operational due diligence — This is an evaluation of the condition of the organisation’s facilities, technology, and assets. The purpose of this is to uncover any hidden risks or liabilities.
- Business due diligence — This is used in mergers and acquisitions. It is focused on a company’s industry and customers to forecast the business advantages and disadvantages of acquiring the customers.
- Environmental due diligence — This is a verification that the company’s processes are compliant with the environmental protocols of the country and industry. This is both an ethical and financial check because there can be fines if the environmental standards are not met.
What is Soft Due Diligence:
Soft diligence is a corporate social review. Soft diligence includes:
- HR due diligence — This is an investigation to determine the organisation’s structure, union contracts, compensation schemes, benefit schemes, vacancies and any HR related lawsuits (harassment disputes, wrongful terminations, etc). The purpose of this is to see how the employees as a whole are an asset to the organisation. If there is a good working environment, then the employees will be more loyal and hard-working.
- Strategic fit due diligence — This is used in mergers and acquisitions to assess whether the company being acquired aligns with the one buying. The purchasing company should assess whether the two would benefit from a merger.
- Self Assessment — The organisation makes a checklist of what is important to them and what steps to take for their due diligence.
- Customer Reviews and Test Market Data — This helps the company understand the loyalty of the customers and the customer experience. It will help them develop better practices and see if their customer base would transition successfully, in the case of a merger or acquisition.
- Employee motivation — As mentioned, this is key to see if a company is successful or not. If the employees are motivated, then the company is 21% more profitable.
What is a Due Diligence Checklist:
Some organisations may have a checklist of what steps are necessary when doing their due diligence. This is one of the first steps when performing due diligence. A checklist allows the process to be transparent and methodical. It is important that you, as a buyer, ensure that every element necessary is checked and not forgotten. Lists help remind us of essential information. To be successful, a due diligence checklist should incorporate all aspects of both hard and soft due diligence.
How to successfully do your due diligence:
Firstly, before you even write out your checklist, you have to define the scopes of your investigation. When doing your due diligence, what exactly are you looking for? What do you hope to accomplish? Knowing this will help you achieve the goals set out in the checklist you make.
The next step after the checklist is the most important part. You have to recruit the team for this exercise. They should be capable and aware of their responsibilities, so they can perform their tasks accurately and promptly. Then, everyone involved should sign a confidentiality agreement, because the last thing you want is sensitive information discussed outside the confines of the investigation! It is also important to use a platform that is secure and trustworthy to share and store said information. Then it is time to start ticking items off!
In a merger or acquisition, it is crucial to involve management from the other organisation. Both parties should be transparent and upfront with each other. Hiding the skeletons in the closet will only damage you both later on!
The final step in successfully doing your due diligence is the report. You need to produce a report that is comprehensive and makes a clear recommendation for the path forward. In a merger or acquisition, the benefits and pitfalls will be weighed out to draw a conclusion of whether this should happen and what would need to be done if it did. In a general review of an organisation or project, the successes and failures will be at the forefront and recommendations for improvements will need to be made.
How can a board portal help you do your due diligence:
A board portal is a platform to share and store information that is secure and trustworthy. We are certified CMMI Level 5 and uphold the industry's highest security standards including AICPA SOC 2/3, ISO 27001, 27017, and 27018. Convene can also help you with due diligence in small but impactful ways. For example, our meeting minutes feature ensures that your minutes are always accessible for any auditing needs.