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MBA Mondays: What Is Due Diligence?

I’m going to try to address business and MBA topics on Mondays where possible.  I’ll start with a simple discussion on due diligence.

Due Diligence. I hear these words so often I can’t even remember how many times.  In fact, I’m sure I’ll hear them before today is over as well.

But what does the phrase, Due Diligence really mean?

Wickpedia defines it as “A term used for a number of concepts, involving either an investigation of a business or person prior to signing a contract, or an act with a certain standard of care.”

Investopedia defines it as “An investigation or audit of a potential investment.  Due diligence serves to confirm all material facts in regards to a sale.

At it’s simplest form I think it comes from contract law and refers to the level care a company is required (due) to make before entering into an agreement with another company (by being diligent).

At investment banks, it is the process by which bankers assesses the appropriate marketing strategy and develops the appropriate list of potential acquirers for a client.

In practice the due diligence process varies from, industry to industry, firm to firm as well as deal to deal.

In venture capital, it means the process by which a VC firm learns all he or she needs to know about a potential investment.

And in the legal world, it means the process of doing a thorough investigation of a company as a first step in a pending merger or acquisition.

In every deal I’ve been on, due diligence has been different.  The merger agreements looks different. The checklist all turn out different. And the number and types of documents reviewed is drastically different.

With VC firms, diligence is about making phone calls and taking meetings with people who know the company.

For PE firms, diligence is about running the numbers, looking at similar companies and understanding the operations of a company to come up with the true value of the company.

For legal due diligence, we have to understand both the business issues and the legal issue to help clients uncovering the necessary risks.  Sire the people, the market, the technology matter, but we do a deep dive into the agreements that can at times make or break a deal.  We look for provisions such as change of control, right of first refusal, competition, and other covenants, and we focus on the terms of the most valuable customer and vendor contracts.

In the end, we can never do enough due diligence.  We can and should request and read every document.  Uncover ever risk and opportunity.  Think in detail about everything we find. And be sure we communicate that to the client.

Due diligence can be absolutely critical in corporate law.  Be sure check out later posts on due diligence for more detail.

Tags: MBA Mondays