The analysis of the company's activities is a common process carried out through the so-called audit. However, there is another thorough process, which examines information and documentation of the company, different from audit, known as due diligence.
Due diligence is commonly used in the sale or merger of a certain company. This prior assessment allows those involved to have knowledge about the company's financial situation, risks and possible opportunities.
Do you want to know more about the importance of this article? So just move on and have a good reading.
Due diligence: what is the origin of the word?
The word due diligence in the literal translation would be something like prior diligence. This term was already present in London legislation of the 19th century, specifically cited in the “Official Collection of London Legislation” in 1854.
However, it was present in the market with greater impact and, with its current characteristics of prior analysis of a company, from the American decree of 1933, US Securities Act.
The decree allowed the negotiation intermediaries to carry out the due diligence process, that is, of prior assessment of company documents and information, and passed on to investors.
So, from that 1933 decree, due diligence began to be used frequently in the market almost as a support for anyone wishing to carry out any type of acquisition or investment in any company.
What is due diligence?
Due diligence it is a process of detailed analysis of information and data of a company. It is usually used when there is some kind of negotiation around this company.
Whether in merger or sale operations. It serves as a demonstration of the organization's assets and liabilities to prospective investors providing the basis they need to assess purchase guided by hard data.
What is the difference between due diligence and auditing?
There are several doubts about the differences between auditing and due diligence. The truth is that they are not the same and differ on several points. Among them we can highlight three:
- Due diligence focuses on risk analysis and the audit does not have this objective;
- The audit uses analysis based on sampling, whereas due diligence uses all possible and available data;
- The audit is technically accounting, while due diligence focuses on evaluative characteristics.
If you want to know more about the role of auditing in internal processes, read our article on the topic clicking here.
What data make up due diligence?
This thorough diagnosis, made in due diligence, is based on information taken from different sectors of the company. Since, in this process, each data is essential for the transaction to be completed.
Therefore, we can highlight the following data as important for due diligence:
- Accounting and tax;
- Labor and social security;
- Assets and liabilities;
- Loans, debts and funds;
- Environmental, legal and real estate.
With the information on each of these topics in hand, it is possible to carry out a tax, risk, financial and legal analysis of the company.
How does the due diligence process work?
We can divide due diligence into three stages, which are fundamental for the information to be collected correctly and the data to have a basis for decision making.
Check out what they are:
Setting up a multidisciplinary team
The first step is to assemble a multidisciplinary team from the most diverse areas of the company, from the administrative to the accounting sector, so that it is possible to carry out the data survey.
It is important in this step that the auditor has a good relationship with the professionals and values good communication between them so that no information is hidden.
It is clear that before this team is assembled, it is necessary to be based on the main objectives and information that the interested party is requesting. Another fundamental point in the due diligence process is the confidentiality agreement.
It is essential that throughout this audit all those involved, who will have access to this confidential information, sign this term in order to avoid leaks and to have legal support in case any data comes up without permission.
Data collection and report building
In the second step of due diligence, we can include data collection and especially the construction of the report with all the documents and information previously described.
At that moment, there should be a compilation of all data, data accounting administrative and labor law.
Information about the company's past, present and future that may arise based on tax books, liabilities and assets, data on employees (salaries, benefits), contracts with suppliers, tax and tax declarations.
Each of these pieces of information will serve as support for the scratchs and opportunities are exposed and contribute to decision making. It is important to note that this process is laborious and usually takes a long time to be effective.
Data analysis and decision making
The third and last item related to due diligence is related to data analysis and, finally, decision making in relation to a sale or merger. It is at that moment that those involved in the business can concretely assess the reality of the company.
With this it is possible to identify strengths and weaknesses, risks and opportunities of the company in question. This means that with due diligence everything is done in the open, preventing a decision from being made on impulse or in the dark, without a basis.
What are the advantages of due diligence?
The due diligence process brings with it several advantages that guarantee greater reliability in a transaction for the acquisition of a certain company or even a merger. Check out some of these advantages below:
- Assists in risk prevention before a transaction is completed;
- Increases the vision about the company's future in the medium and long term;
- Contributes to the identification of financial problems;
- It serves as a basis for the construction of a subsequent financial planning;
- It allows to raise positive and negative points of the organization in different sectors, from administrative to accounting;
- It brings a more concrete view of possible future opportunities;
- It exposes possible fraud and operational limitations of the company.
Are there any negative points in due diligence?
The consequence of due diligence has a positive character so that a decision is made based on something, minimizing errors.
However, for the company involved it can bring some negative aspects of the organization to the fore. With this, some situations of due diligence are:
- Withdrawal from the purchase or merger negotiation by the investor;
- Discount on the operation due to the exposed financial problems of the company;
- If the purchase or merger was completed before due diligence, the buyer can claim compensation from the seller.
Due diligence and the quality seal
In the market in general there is always that incessant search for the famous seal of quality. Is something good or bad? Do I take a risk or not take a certain investment? Is it cold or opportunity?
Due diligence emerged exactly to provide answers to these questions in a concrete way. It unravels each area of the company so that an acquisition or merger business is carried out strategically.
After all, who will want to buy something broken and that has no more repairs, and can invest in something that can be opportune and full of opportunities.
The broad view that due diligence brings allows any decision is strategic, as those involved will know exactly the reality of the business. Avoiding high risks and prioritizing what can still bring results.
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