What is due diligence? In this article, we’ll discuss due diligence, what it is, why it’s important, what it involves, and more.
Table of Contents
What is Due Diligence
Due diligence is a process or effort to collect and analyze information before making a decision or conducting a transaction so a party is not held legally liable for any loss or damage. The term applies to many situations but most notably to business transactions. Due diligence is performed by investors who want to minimize risk and companies who are considering acquiring another firm. Fundamentally, doing your due diligence means that you have gathered the necessary facts to make a wise and informed decision.
In addition to risk mitigation, the due diligence process is designed to uncover any unknown facts with the ability to analyze their effect on the transaction. Some issues may easily be resolved while others can be cause to break the deal.
It is worth mentioning that some parts of the due diligence process may be considered more important by some compared to others. Equally, some will matter more for some business models versus others. Regardless of this, all aspects should at least be examined to some extent.
What Does the Due Diligence Process Involve
The due diligence process can be scaled up or down depending on the transaction. The due diligence requirements should look different when purchasing a $10k Shopify App, a $350k affiliate website, or a $3.5M multi-national ecommerce business.
Preparation is key to conducting an efficient due diligence process.
- Communicate expectations between buyer and seller
- Prepare a due diligence timeline.
- Prepare a due diligence questionnaire
- Prepare a due diligence document request
- Prepare a due diligence checklist(s)
- Prepare your due diligence team.
Communication and mutual respect between buyer and seller are vital for this process. Make sure the seller has a clear understanding of your due diligence process and does not encounter any surprises. Smooth due diligence can go a long way towards building long-term trust between all parties.
Due Diligence Timeline
Use reasonable effort to estimate the amount of time that the due diligence process will take. Due diligence for a midmarket transaction takes 2 – 3 weeks. Due diligence for a micro-acquisition should not take more than a week or two. Clearly communicate your timeline with the seller to set proper expectations.
Due Diligence Questionnaire
You may want to prepare a questionnaire for the seller with some basic due diligence questions. This document may be helpful for you to reference as you go through the due diligence process.
Have a clear outline of the documents which you will require the seller to produce. Strike a balance between your needs and the burden placed on the seller. Very few transactions would necessitate 20-years of P&L statements. Anything that’s a micro or SME acquisition, 3 – 5 years of financials should be sufficient.
Due Diligence Checklist(s)
The checklist is your roadmap of the due diligence process. The checklist is meant to keep the due diligence process focused and to make sure no detail is overlooked. You can separate the checklist into multiple areas such as technical, financial, legal, online, operations, and more.
The right team will cover your blind spots and add value by mitigating risk. A team may include an attorney, a CPA, a technical expert, an M&A advisor, a marketing expert, a supply chain expert, and more. At the very least, you want to have someone available who can review your due diligence work and spot any red flags that you may have missed.
We built DueDilio to help investors and business buyers hire on-demand due diligence experts. Whether you need a quick consult or a full due diligence deep-dive, our network of experts have you covered.
How Long Is the Due Diligence Period?
A buyer has a fixed period of time following a letter of intent (LOI) to do due diligence. The LOI will specify this period, which is negotiable. Due diligence can take anywhere from a few days to several months, depending on the complexity of the transaction. If there’s good cause and agreement by both parties, the period may be extended.
The due diligence period should allow the seller to:
- Compile and produce any necessary data & documentation
- Grant access to any relevant systems
The due diligence period should allow the buyer to:
- Engage due diligence experts to help mitigate risk
- Review & analyze all data & documentation produced by the seller
- Review any systems which are in place
- Physically inspect any assets, when relevant
10 Basic Due Diligence Areas
The due diligence checklist should be tailored to your specific transaction. Below is a list of the most common due diligence areas.
- Human Resources (HR)
- Intellectual Property
- Information Technology
- Environmental, Health and Safety (EH&S)
- Compliance and Regulatory Matters
DueDilio connects business buyers and investors with quality on-demand due diligence experts. Our wide network of experts can assist with technical, legal, finance, operations, sales, marketing, and other types of business due diligence. Whether you need a one-time consult or a due diligence deep-dive, DueDilio has you covered.