Due diligence is an investigation or audit of a potential investment or product to confirm all facts, such as reviewing all financial records, plus anything else deemed material. It refers to the care a reasonable person should take before entering into an agreement or a financial transaction with another party. Due diligence can also refer to the investigation a seller does of a buyer; items that may be considered are whether the buyer has adequate resources to complete the purchase, as well as other elements that would affect the acquired entity or the seller after the sale has been completed.
In the investment world, due diligence is performed by companies seeking to make acquisitions, by equity research analysts, by fund managers, broker-dealers and of course by investors. For individual investors, doing due diligence on a security is voluntary, but recommended. Broker-dealers, however, are legally obligated to conduct due diligence on a security before selling it. This prevents them from being held liable for non-disclosure of pertinent information.**
The Due Diligence Process
Below are detailed steps for individual investors undertaking due diligence. Most are related to equities, but aspects of these considerations can apply to debt instruments, real estate and other investments as well.
Step 1: Analyze the Capitalization (Total Value) of the Company
Step 2: Revenue, Profit, and Margin Trends
Step 3: Competitors and Industries
Step 4: Valuation Multiples
Step 5: Management and Share Ownership
Step 6: Balance Sheet Exam
Step 7: Stock Price History
Step 8: Stock Options and Dilution Possibilities
Step 9: Expectations
Step 10: Examine Long and Short-term Risks
Step 11: Analyze the Intelletual Capital (Total Hidden Capital) of the Company
Step 12: Analyze the Brand value of the Company
All this step Due diligence questions to be answered when completing M&A or a simple business purchase.
Who creates a due diligence report?
There can often be many groups involved in preparing the due diligence document. Companies may carry out the analysis internally with their corporate development team, or they may hire external advisers like investment bankers or the Due Diligence Team at an accounting firm.
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