When you’re thinking about an investment of a significant amount or entering into a contract with another firm due diligence is vital. It will aid in avoiding costly mistakes or put you in a stronger negotiating position when it comes time to determine the terms of the agreement. But identifying flaws and risks does not mean you must abandon a deal altogether particularly if the issues can be overcome with the right strategy.
In the legal and business world, «due diligence», initially, referred to how much diligence a reasonable person could take when examining important future issues. The investigation would focus on issues that could affect future decisions such as mergers and acquisitions, or investing in an offering of shares. The brokerage industry quickly standardized the practice of due diligence as an established procedure. Brokers who conducted due diligence on an equity offering were required to research the company thoroughly, and then report their findings to individual investors.
There are five primary types of due diligence: financial, commercial and environmental, intellectual property and cyber. The most effective due diligence systems maintain a close collaboration between these different areas, even though each will require its own team of experts. Work in one area can influence the checks executed in other areas.
For example the process of financial due diligence usually concentrates on ensuring the projections outlined in the Confidentiality Information Memorandum are accurate. This requires a thorough review of all financial data and reports including but not limited to audited or unaudited financial statements in the past and present budgets, cash flows, capital expenditure plans, as well as inventory.