Due Diligence: A Definition

What is due diligence?

Due diligence is the practice of undertaking sufficient fact-checking before proceeding with a transaction. In business, undertaking due diligence can be a legal requirement (e.g. anti-money laundering checks). Even when it isn’t, it is generally a very sensible means of mitigating the risk in any business transaction.

Example of due diligence

Due diligence can be performed on a person, company or entity. The nature and thoroughness of the due diligence process will generally be determined by the situation.

For example, a very basic level of due diligence for employers is making sure that all employees have the right to work in the UK. If an employee was being hired for a more sensitive position, an employer might feel it appropriate to conduct criminal records checks. If an employee was being hired for a highly sensitive position, it could be entirely reasonable for the hirer to conduct extensive background checks.

Similarly, if a business is considering entering a commercial relationship with another business or another entity, they would usually undertake some level of due diligence on them. Again, what this would mean in practice would depend on the situation.

For example, if a company was just hiring a supplier for general work, the hirer might simply want to know that they were qualified, registered/licensed and insured. If, however, they were considering a merger with or acquisition of another company, they would need to do many more in-depth checks on both the company itself and the seller.

Due diligence vs auditing

Due diligence and auditing are essentially the same concept. The only real difference is that companies undertake due diligence on other people, businesses or entities. They are subjected to audits.

Audits are a legal requirement for some companies. For example, companies involved in financial services are likely to be required to have periodic audits, as are public limited companies and their subsidiaries. In these situations, the auditors are usually paid out of the company’s funds. Their responsibility, however, is to the company’s customers and/or shareholders rather than its directors.

Companies may also choose to undergo voluntary audits. These would typically be to reassure customers and/or investors. For example, customers, in general, are becoming increasingly aware of cybersecurity and privacy. Companies may therefore choose to undergo third-party certifications such as ISO 27001. These types of certifications are effectively internal due diligence reports.

International due diligence

Any firm that operates across borders in any way needs to undertake international due diligence. Most businesses will operate across borders to some extent, although they may not actively realise this. For example, most businesses will take some payments from customers who live overseas. This means that they need to do suitable international due diligence.

Fortunately, in most cases, this will require minimal input from the business.

For example, if a business accepts payment cards issued by banks in other countries, the banks will have done the necessary checks. These will have been based on applicable laws plus card-scheme rules. The merchant simply needs to follow all applicable laws and card-scheme rules when accepting the card. They will usually be guided on this by their merchant service provider.

If a business is sending goods across borders, then they will need to ensure that they comply with the law both in their own country and in the country to which the goods are sent. Again, though, this is not likely to be a huge issue for most businesses, especially small businesses. However, for buying goods from overseas, it’s also highly advisable to check the legal situation before making the purchase, especially if they are intended for resale.

If a business is going beyond this, for example, working with an international partner or setting up an operation overseas, then the due diligence process takes on a whole new level of importance. In these kinds of situations, it’s vital to get impartial legal advice from experts who are familiar with the relevant territory and its laws, regulations and practices.