A popular phrase in business, due diligence refers to take reasonable care and caution. Investors who wish to reduce their risk do their own due diligence prior to investing. Broker-dealers are required to inform an outside party of all information about transactions in order to avoid being held responsible. Companies considering acquiring another company also conduct their due diligence.
This article reviews the different types due diligence and how they relate to the overall process.
The most basic type of DD is regulatory due diligence, which focuses on the legal or compliance risks associated with the transaction. This kind of DD is especially relevant in industries that have strict regulation requirements, such as healthcare and finance where a breach of compliance could result in penalties, fines or even the possibility of a shutdown.
Financial due diligence (FDD) is the most widely-used form of DD and seeks to check whether the financials provided in a Confidentiality Information Memorandum have been compiled in a reliable manner. It typically involves reviewing all financial statements, assets, liabilities and cash flows, as well projections. FDD also examines agreements and contracts, including partnership and licensing agreements, term sheets, and loan and bank financing agreements.
Administrative due diligence is a type of due diligence that focuses on administrative-related items. For example, this type of DD looks at the number of facilities that are owned or leased by a company, the occupancy rates of these facilities, and the levels of staffing. It may also involve examining employment contracts, nondisclosure agreements, non-solicitation agreements as well as other documents pertaining to human resources.
