What is a due diligence?
Due diligence is common practice in the business world and comes in various scopes. This article seeks to give some insights into a due diligence exercise or investigation.
In simple terms a due diligence exercise (“due diligence”) is an investigation done by one party on another, whether the latter is a reasonable to suitable party, for purposes of entering into an intended business arrangement or agreement. The exercise is meant to gather information on a party and use the information to evaluate the party and in most cases the proposal by the party, in order to make an informed business decision. Due diligence can be interpreted as required or reasonable care one should exercise especially before committing to a business arrangement. It can be likened to an interview and other assessments done by an employer before hiring a prospective employee. Jokingly it is used to emphasize the need to assess a party before committing to a marriage. A due diligence can be voluntary or involuntary but in most cases it is by agreement.
Situations where a due diligence is recommended
Examples of situations where a due diligence exercise is recommended include the following:
- Where an investor intends to acquire significant or controlling stake in an existing company.
- Where an investor is being invited by another party to participate in a business arrangement for example a joint venture or partnership. In that case a due diligence becomes necessary on the inviting party and the intended business arrangement.
- Where parties intend to merge their businesses.
- In the case of a major or long medium to long term supply arrangement or contract.
- In the case of loans, credit sale, advance payments, leases.
- In the case of an intended distributorship, dealership, agency or other arrangements.
Scope of a due diligence
What a due diligence covers depends on the intended use of the results by the prospective investor or beneficiary to a transaction but may cover the following:
- The industry the target company or investee company operates.
- Business of the target company
- The other party to a transaction e.g. other shareholders, supplier, customer, borrower, etc. This may entail their capacity to perform, integrity, business history, history of disputes, etc.
- Business of the target company
- The target company itself. This may include a review of the company’s business model, corporate strategies, governance structures and systems, financial performance especially profitability and solvency, markets and marketing strategies and practices, operations or production capacity and systems, information technology, accounting and internal controls, risk and compliance, exchange control, taxation, completeness of indebtedness, litigation and outstanding legal matters, and many other issues.
- The anticipated business arrangement. This may cover feasibility, viability, financial viability, risks and opportunities, contributions by and roles of each party, financial benefits, etc.
- Valuation of the target business or intended business arrangement. This helps place a value, for example the acquisition price to pay. Valuation is a complex exercise and requires knowledgeable professionals. It involves taking into account many factors and needs good judgement.
Who may carry out a due diligence?
Depending on the intended purpose a due diligence may be carried out by or through a combination of the following professionals, not exhaustive or listed in any particular order:
- Finance people such as Chartered Accountants, holders of CFA, CPA, ACCA, CIMA qualifications,
- Commercial lawyers
- Business and transaction advisors
- Business rescue practitioners
- Stockbrokers
- Bankers
Godknows Hofisi is a lawyer, chartered accountant and business rescue practitioner. He writes in his personal capacity. He can be contacted on +263 772 246 900 or gohofisi@gmail.com
