Due diligence is the formal process of investigating the background of a business, either prior to buying it, or as another party in a major contract.
It is used to ensure that there are no hidden details that could affect the deal. Due diligence is an investigation, audit, or review performed to confirm the facts of a matter under consideration. In the financial world, due diligence requires an examination of financial records before entering into a proposed transaction with another party.
Due diligence became common practice and a common term in the U.S. with the passage of the Securities Act of 1933. With the enactment of that statue, securities dealers and brokers became responsible for fully disclosing material information about the instruments they were selling. Failing to disclose this information to potential investors made dealers and brokers liable for criminal and civil prosecution.
Due diligence is also the care that a reasonable person exercises to avoid harm to other persons or their property. Due diligence means doing your homework before you pull the trigger on a property or business purchase, often with the help of legal or business professionals.
The due diligence process usually includes getting answers to questions such as these:
- Does the business have healthy cash flow?
- Are profits going up or down?
- Are there any major new competitors in or coming into the area that could negatively impact earnings?
- What kind of online presence does the business have, and how does it compare to its competitors?
- If the company has physical assets, are they valued correctly and fairly?
- Are there any hidden liabilities?
- Are the company documents complete?
- Is the business up to date on its taxes?
- Does it lease property?
- If so, when does the lease end?
- What insurance information is provided and what is covered?
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