Due diligence is the process of investigating, researching, and analyzing a potential decision before making a choice. Lawyers and investment bankers often perform due diligence on large-scale transactions to ensure their clients make informed decisions. However, everyone engages in due diligence whenever they read reviews or compare options before making a purchase.
Due Diligence Meaning
It can be challenging to define due diligence because it has two primary applications: a professional use case and a day-to-day, colloquial usage. In our daily lives, we perform due diligence by applying critical thinking skills to decisions. For instance, if you watch a few video reviews of a vacuum cleaner before purchasing, you’ve performed due diligence.
However, in professional spaces, especially business and finance, due diligence is the process of researching, analyzing, and avoiding risks from business or investment decisions. For example, a company performs due diligence by reviewing a potential acquisition’s fiscal history and financial records before agreeing to the deal.
Due diligence became a common practice in finance and business after the Securities Act of 1933. This act requires securities salespeople to provide a prospectus for each security they put for sale. A prospectus includes all the information an investor needs to perform due diligence and make informed decisions, including:
- A description of the company
- A description of the security being sold (stock, bond, option, etc.)
- Details about the company’s executive management
- Third-party-verified financial statements
By requiring this information to be publicly available, consumers and businesses can more safely invest.
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Careers that Involve Performing Due Diligence
Because due diligence involves reviewing information and determining risks before making decisions, many different careers and industries perform due diligence every day. Some common careers that require this skill include:
- Financial analysts
- Investment bankers
- Accountants and auditors
- Business analysts
Types of Due Diligence
Performing due diligence is a similar process regardless of the decision you’re investigating — gather information, analyze it critically, and use the research to inform your decision. However, what information professionals review varies greatly depending on the type of due diligence.
Due Diligence in Real Estate
When purchasing a home, you may undergo some form of due diligence by requesting energy audits and inspections and walking through the property yourself before signing.
In commercial real estate, due diligence is a little more complicated. Lawyers and business analysts review a lot of information before a commercial real estate transaction happens, like:
- Zoning laws: Can a commercial developer build on this piece of land? What activities are allowed in this area?
- Environmental concerns: Is the land protected under conservation rules, or are activities restricted because of neighboring protected areas?
- Property conditions: What shape is the property in? Will repairs be necessary?
- Earthquake and flood potential: Will the property be at risk of damage in the near future because of flood zones or seismic activity?
- Titles and certificates of occupancy: Who has owned the property before? Is it legally allowed to be sold?
- Applicable tax incentives: Does the property qualify for special tax breaks, or has it qualified in the past?
- Property value: How much does the property currently cost?
- Additional costs of purchasing the property: Are there other structures or features that may increase the cost? Does the seller have specific requirements as part of the sale?
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Financial Due Diligence
While making an informed purchase can count as due diligence, financial due diligence primarily refers to the process of reviewing information related to mergers and acquisitions (M&A), taking private companies public through initial public offering (IPO) or special purpose acquisition company (SPAC) processes, or investments.
M&A Due Diligence
A merger involves two or more companies combining into one entity and merging their staff, management teams, and product offerings. On the other hand, an acquisition is when one company purchases another company outright, taking control and ownership of the business. In either case, all parties want to know what they’re getting into.
By performing due diligence, the buyer knows exactly what they’re paying for, and the company being merged with or acquired understands the terms of the agreement. Investment bankers, financial analysts, business analysts, and lawyers perform the in-depth analysis required for these massive transactions.
Professionals review details and information like:
- Bank account records
- Business holdings, both domestic and overseas
- Assets and liabilities
- Financial statements and records, like cash flow statements and balance sheets
- Lists of current and former employees
- Legal and tax statuses (e.g., nonprofit, LLC, or LLM)
- Company history and timeline
- Previous mergers or acquisitions the company has been part of
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Investment Due Diligence
Investors often perform due diligence before putting their money into the stock market to ensure they’re making informed decisions. If you’ve ever invested, perhaps through investing apps or programs like Robinhood or Fidelity, you may have practiced the same type of research professional investors do when choosing where to put their cash.
Investment due diligence requires:
- Reviewing the company’s history
- A thorough stock technical analysis
- Understanding the potential investment’s reputation
- Looking at how the company has historically complied with laws and regulations
- Researching the types of investment options available, such as options, bonds, or stocks
Companies publicly traded on stock exchanges must provide financial records to the Securities and Exchange Commission (SEC). So, it’s easy to look at historical trends and understand how and where the company spends and saves money.
Investing in private companies through venture capital firms, private equity firms, or angel investing requires more digging (and more faith and risk assumption) to make an informed decision since these companies aren’t required to disclose financial information publicly.
>>MORE: Learn the differences between venture capitalists and angel investors.
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Legal Due Diligence
Lawyers often perform due diligence in mergers, acquisitions, and investments. In contract law, commercial law, and corporate law, this type of intense research is a daily practice. To help their clients avoid risky investments or deals, lawyers on both the buyer’s side and seller’s side review:
- Any contracts the parties may currently be legally bound by
- Potential, pending, or ongoing lawsuits
- Debts, liabilities, and assets
- Information regarding the companies’ business processes, compliance history, and regulations
- Locations of operations
- Import or export restrictions
- Tax history
- Existing warranties or obligations
>>MORE: Hear from five attorneys on how they found their way into law.
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Customer Due Diligence
Banks and financial services institutions perform customer due diligence (CDD) while underwriting and accepting new customers. In an effort to assess risks and avoid unwittingly participating in financial crimes, banks want to understand who they’re lending money to or opening accounts for.
Banks look at:
- Customer identity, verified by birth certificates, social security cards, and passports
- Available banking history, like if the customer has previously had an account with the bank
- Sanctions or restrictions placed on the customer by regulatory authorities
- Background checks to ensure the customer is who they claim to be and to see if there is a history of financial crimes
CDD is an ongoing process, though. Banks monitor customer deposits, withdrawals, and account activity to catch suspicious behavior early. While this oversight may seem invasive, it also helps customers stay safe from identity theft or other criminal activity. Sudden changes in banking activity can be a sign that someone has accessed your bank account or credit card information, so if the bank catches it quickly, you can prevent a larger headache down the line.
How to Do Due Diligence
In your personal life, you can practice performing due diligence by researching and reviewing the details of a transaction or decision before committing. Whether you’re buying a new car, investing $100 in the stock market, or choosing what to have for dinner tonight, you participate in the due diligence process by looking at the risks involved in your decision and making thoughtful and informed choices.
Professionally, due diligence follows stricter steps. In an M&A process or a legal situation, analysts create a checklist. This checklist includes the steps needed to complete the due diligence process and every piece of information that analysts will review before making a decision. Often, professionals will gather the information first and then analyze it.
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Example Due Diligence Checklist
In investment banking, the due diligence step of a merger or acquisition occurs once a target company has been identified. The steps an investment banker or financial analyst goes through are:
- Plan the investigation process
- Determine who will be involved in the process
- Define the protocols, methods, and approach to the process, including what information will be reviewed
- Gather the information
- Analyze the information
- Report findings from the research
In step 3, analysts create a list of information to look at. This list includes:
- Company finances
- Company overview and history
- Company assets, both tangible and intangible
- How the company will fit into the buyer’s business strategies
- The target company’s customers
- The structure and management of the target company
- Any legal issues regarding the target company
- Environmental concerns related to the merger or acquisition
- Production processes and capabilities
- Marketing plans
Once the team gathers this information, they perform an in-depth analysis to determine if the target company would be a strategic and beneficial purchase or merger.
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Showing Due Diligence Skills On Resumes
If you have work or internship experience assisting in a due diligence process, you can list it in the skills section of your resume or mention it as part of the description of the relevant job or internship.
You can also show due diligence skills by including related abilities in your skills section, such as:
If you don’t have any relevant professional experience using due diligence, your cover letter is a great place to discuss personal uses of due diligence or elaborate on related skills. For instance, if you casually invest in stocks, you can talk about your research process for choosing where to invest. Or, if you have strong research, analysis, and decision-making skills, you can give concrete examples of how you’ve used these skills in school, work, or your personal life.
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Related Skills for Business and Finance
Professionals in law, business, banking, or finance rely on due diligence, research, and analysis every day. Other skills these careers often require include soft skills, like:
In a business or finance career, you should also have hard skills, such as:
- Understanding agile methodologies
- Familiarity with Microsoft Office programs, like Excel and PowerPoint
- Data collection and analysis
- Experience using financial metrics in analysis, like profit margins and current ratios
Explore the skills employers are looking for with our skills articles.
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