Due diligence is a phrase that is often used in the business world. It is the act of acting with care and prudence. Investors who wish to reduce the risk they take must do their own due diligence prior to making an investment. Broker-dealers must inform the third party of all information about transactions to ensure that they do not get legally liable. Companies who are contemplating acquiring another company must also conduct due diligence.
This article examines the different types of due diligence and how they are related to the overall process.
The first and most basic form of DD is regulatory due diligence, which examines the compliance or legal risks associated with the transaction. This type of DD can be particularly crucial in industries with high regulations, such as healthcare and finance where a breach of compliance could result in fines, penalties or even a shutdown.
Financial due diligence (FDD) is the most widely-used form of DD and is used to verify whether the financials showcased in a Confidentiality Information Memorandum have been compiled in a reliable manner. It usually involves looking over all financial statements as well as liabilities, assets and cash flows, as well as projections. FDD also reviews contracts and agreements, including partnerships and licensing agreements, term sheets loans and bank financing agreements and many more.
Administrative due diligence focuses on verifying admin-related items. This kind of DD is, for instance examines the number and occupancy rate of the facilities owned or leased, as well as the levels of staffing. It may also look at employment contracts as well as nondisclosure agreements.