You can dissect the due diligence process into several areas; for example, financial, legal, commercial and environmental. These can be complex areas and it is only by seeking advice from an expert, such as an accountant or lawyer, that you can be confident you have covered everything. It is also important that you communicate with your advisers throughout to ensure your due diligence is as thorough as possible.

Scope of due diligence

Any potential investment has its own unique characteristics. These characteristics will dictate the size of the task. You should agree the scope of the work with your advisers by drawing up terms of reference.

Financial due diligence, for example, will be influenced by the following:

• The nature of the transaction – due diligence will be different when buying shares in a company compared with buying an asset or trade out of a company
• The industry in which your target investment operates
• The information that a seller makes available to you
• Your own ability or capacity to take on some of the work
• Any areas that particularly concern you.

A typical financial due diligence will analyse the following areas:

• Past performance, profitability, liquidity, assets and liabilities
• Underlying profitability and liquidity, after eliminating one-off, non-recurring items
• The accounting policies the seller uses, how they conform to local Generally Accepted Accounting Practice (GAAP), and any changes needed to align them with your own local GAAP requirements
• The seller’s forecast results and the underlying assumptions
• Accounting and management information systems and controls
• The direct and indirect taxation position, both pre and post-transaction
• Any actual or potential liabilities.

The process

Once you have agreed the work involved, your advisers will ask the seller for the necessary information. This information makes up what you will often see called the ‘data room’ and may only be available for a short time. The seller may insist on you and your advisers signing a confidentiality agreement before releasing any information.

Your due diligence relies heavily on the accuracy of information the seller makes available. This makes communication between your advisers and the seller’s advisers very important.

Reporting to investors

The initial reports you receive as the investor during due diligence will often be verbal as you need to know about any issues as early as possible. The timetable for completing a transaction is often tight and you will need enough time to consider, take action and possibly negotiate with the seller.

The final report you receive should include a summary of the key issues and all associated risks and implications.

The benefits of due diligence

Due diligence will help you:

• Uncover potential deal breakers that may cause you to withdraw
• Spot issues that you may use to negotiate a reduced price, or a revised timing of any payments
• Identify issues that need to be covered in the legal transaction documents and agreements
• Mitigate potential risks
• plan your post-completion strategy

To reap the full benefits of due diligence you must consider and act on any issues and not allow other, more favourable, features to influence you unduly.

In an increasingly challenging global market, the need to make balanced and informed investment decisions is crucial. Due diligence has an important role to play in helping to identify and, where possible, mitigate the risks associated with a proposed investment.