Due Diligence Definition

What Is Due Diligence?

Due diligence is a process for gathering information about another party’s side of a business transaction and ensuring that it is legal. It is required in most business deals. It is completed before a business deal is final in most contexts. Ideally, during due diligence, you and the other party become fully aware of the details of your transaction.

Key Takeaways:

• Due diligence must be completed before a deal is final and can be conducted before and during the negotiations of the business transaction.
• Due diligence is a potential risk to each party.
• Due diligence requires the disclosure of certain facts by each party.

When Does the Due Diligence Process Occur?

Due diligence typically occurs at the end of the business deal. However, due diligence can also occur throughout the transaction. It is the last hashing out of details before the deal is final.

For example, in a real estate transaction, the buyer will ask the seller questions and will get details about the property to make sure that they are getting a good deal. The purpose of due diligence is to make sure that you get a fair and honest deal and that all legal formalities have been followed.

Depending on the type of transaction, the due diligence process may occur before an offer or after the parties sign the contract. During the process, the buyer learns a lot of information that may make them rethink the whole deal.

What Is a Due Diligence Report?

A due diligence report is a physical report that is presented to a prospective buyer which lists pertinent information about the business so that the prospective buyer or investor is able to make an informed decision about becoming involved financially with the business.

A due diligence checklist is a useful tool that helps a prudent person with business decisions. A due diligence checklist usually includes the following:

• Income statements
• Financial records
• Tax information
• Assets
• Legal documents

What Are the Risks of Due Diligence?

Due diligence does potentially expose each party to risk. You may receive information from the other party that is not favorable to you. And, on the other hand, you may have to disclose information to the other party that does not paint you or your side in the best light. The due diligence process may cause the deal to go sour, so some people consider different factors when they are deciding the amount of due diligence to disclose during the transaction.

What Facts Must Be Disclosed During Due Diligence?

You and the other person or people that are a part of the deal will disclose important details of the transaction. The information that you disclose is based on how much due diligence the parties agree to. The types of information that you and the other parties must disclose might include:

• The amount of debt the business currently has
• A description of the property the business owns
• If the business has tax debt
• The true value of a property

Internal Links

• Buying a Business: Due Diligence Checklist