Conducting due diligence entails examining and evaluating any contracts, documents, or other financial aspects of the other person or business before closing the deal.
Every day, millions of business transactions and deals take place throughout the world. Each comes with a certain amount of risk, however, especially when you don’t have proper information about the other company or individual.
So how can you conduct a risk-free business transaction? That’s where due diligence comes in. Conducting due diligence entails examining and evaluating any contracts, documents, or other financial aspects of the other person or business before closing the deal.
As part of the board of directors’ duty of care responsibility, the board needs to perform due diligence on any business or individual before closing any deal to avoid potential scams or financial loss.
This post will take an in-depth look at what due diligence is and how board management software can improve board effectiveness in executing various tasks.
What is Due Diligence?
Due diligence refers to the measures an organization takes to thoroughly investigate and verify the validity of an entity before initiating a business transaction, whether with a third party, vendor, or client. Generally, it entails conducting a background check to ensure the parties to the transaction have the information they need to proceed with the transaction.
Performing due diligence can be challenging, especially since you need to investigate and assess several aspects of the entity before conducting any transactions with them. As best practice, we recommend using a due diligence checklist during the process to learn about the entity’s assets, liabilities, benefits, contracts, and any potential problems.
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Why is Due Diligence Important?
The due diligence process allows investors and companies to understand the nature of the deal, identify the risks involved, and determine whether the deal fits their portfolio. By performing due diligence, buyers can identify and assess the risks, liabilities, and potential problems in the target company or investment before closing the deal, and avoid potential losses and bad press later on. Basically, performing due diligence is like doing ”homework” on a potential deal and it’s crucial to making sound investments and smart business decisions.
Types of Due Diligence
There are different types of due diligence, such as:
- Commercial due diligence: Commercial due diligence assesses whether the deal is financially viable and the likelihood of a good return on investment (ROI). It looks at the market size, market share, customer base, potential future returns, and competitors.
- Legal due diligence: This type of due diligence investigates any potential liabilities of the other entity that could affect a successful transaction. It typically includes carefully examining all the material contracts, including licensing agreements, partnership agreements, term sheets, and loan and bank financing agreements.
- Financial due diligence: Financial due diligence assesses an entity’s financial health to establish future forecasts by factoring in any potential risks. It reviews financial statements, assets, liabilities, cash flows, and projections to determine whether they are accurate and true.
- Tax due diligence: This type of due diligence involves the analysis of all the different taxes applicable to a business, depending on its jurisdiction and tax obligations.
- Intellectual property due diligence (IP due diligence): In this type of due diligence, copyrights, patents, brand, and trademarks are evaluated to determine their value and how well they are protected and covered.
How to Exercise Due Diligence
How due diligence is conducted differs by transaction, but certain steps are common to each deal. The general due diligence process steps include:
- The definition of goals for the relationship: What is your reason for engaging a new vendor, client, or third party? Understanding how the relationship can benefit your company can help you define the due diligence process since you can also identify the risks that may prevent you from attaining those goals.
- Establishing roles and responsibilities: Depending on the type of transaction, due diligence can be a long, complex process. Define who is responsible for what task —within your organization and within the entity you are assessing—to ensure everyone understands what is expected of them.
- Inspection of documents and/or processes: Depending on the organization you’re assessing, you might look at the IT infrastructure, financial documents, compliance procedures, internal controls, and more.
- Assessing risk management: Assess the risk management strategy of the potential vendor, client, or partner. If they don’t have a risk management plan, partnering with them might be riskier as opposed to when they do.
- Reporting on due diligence: Create a due diligence report that reflects on everything you covered during the due diligence process. You will typically deliver this report to the C-Suite or the board of directors so they can determine whether to follow through with a given business relationship or transaction.
- Monitoring and assessing risks: The due diligence process does not end after the relationship begins or a deal is closed. Therefore, you should develop an ongoing approach for monitoring your new vendor or third party’s activities to ensure they are compliant. This way, you can effectively mitigate any risks that may arise in the future.
Due Diligence Examples
Due diligence can be vast, more so for large and global organizations. Below are a few due diligence examples to help you understand how varied the due diligence landscape is:
- A nonprofit partnering with a managed IT provider would need to examine the IT provider’s cybersecurity to uncover potential compliance issues and security risks.
- A larger company acquiring a smaller competing company would review compensation plans, employment agreements, compliance with any regulations, and labor laws, among other things, to determine if the acquisition will be valuable.
- A corporate governance committee performs a background check on potential candidates for executive roles.
- Shareholders conduct background checks on potential board members to ensure they choose the most suitable candidates. That said, the essential questions shareholders should ask during board member interviews should cover topics related to what they know about the company and why they want to join the board.
OnBoard Powers Effective Boards
The board of directors serves as the engine that drives your organization to success. During interviews and selection of your board members, it’s important to conduct effective due diligence to ensure each person selected can contribute effectively.
Upon finding the right board members, set them up for success with powerful board management software. These solutions can improve their decision-making, effectiveness, and governance.
OnBoard’s board management software provides a cloud-based platform to store and manage board documents, including confidentiality agreements, board agendas, and meeting minutes. OnBoard also powers real-time collaboration and communication among board members, increasing productivity and improving decision-making.
OnBoard comes equipped with the following board management features:
- Industry-leading security, compliance, and data protection that’s certified and accredited
- Agenda Builder and Minutes Builder for simplified meeting administration
- Secure Messenger and Zoom Integration to enhance communication
- Board Assessments to empower boards to measure their performance against the organization’s goals
Ready to learn how OnBoard can improve your board effectiveness? Reach out for a free trial today. We also recommend checking out our resourceful Board Management Software Buyer’s Guide for insights on how your organization can benefit from board management software.
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About The Author
- Adam Wire is a Content Marketing Manager at OnBoard who joined the company in 2021. A Ball State University graduate, Adam worked in various content marketing roles at Angi, USA Football, and Adult & Child Health following a 12-year career in newspapers. His favorite part of the job is problem-solving and helping teammates achieve their goals. He lives in Indianapolis with his wife and two dogs. He’s an avid sports fan and foodie who also enjoys lawn and yard work and running.
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