One of the most important processes a private equity firm can undertake is due diligence. It is the firm’s obligation to its clients to perform this important duty after all, which is why it’s important to understand everything about the due diligence process, why it happens, what it involves, and why businesses should practice their share of due diligence.
What is Due Diligence?
Simply put, private equity due diligence is a detailed investigation of the value of a potential investment, company, or product. This process includes reviewing all financial records such as revenue, customer base, and other valuable information to assess the total valuation of an entity. The term ‘due diligence’ references to the caution that reasonable people should take before entering into financial transactions.
After the passage of the Securities Act of 1933, due diligence became a more common practice in the United States. Under the act, securities dealers, brokers, and other financiers became responsible for disclosing all material information in full; as it related to the commodities they were selling.
Should there be a failure to disclose this information, dealers, and brokers could face criminal charges. That is, however, until Congress wrote language into the bill that would serve as a legal defense. Dealers and brokers now had the responsibility of exercising due diligence, by investigating companies thoroughly and fully disclosing all pertinent information to potential investors. So long as dealer and brokers could prove they exercised a thorough investigation, then they could not be held liable for any information not discovered by the investigation.
The Process of Due Diligence
The process of due diligence is a standard affair. In fact, all initial public offerings (IPO) begin with the standard due diligence meeting. During this process, an underwriter will ensure that all pertinent information has been disclosed to all potential investors. After which, a final prospectus is issued and all parties involved, agree on the legality and finer points of the transaction.
Sounds simple enough, except that the investigation is much more thorough. During the due diligence process many important aspects of a business are scrutinized, from financial statements to cash flow, but most importantly, investors are often seeking to know how the business or company will do in the future.
Investors want to make sure they’re investing their money wisely, and that the return on investment will be worth their while. No one wants to invest in a company that has no future. Part of due diligence is analyzing a profile of a company or business. For example, investors should review the total value of the company, including how big the company is. Understanding a company’s market capitalization helps investors understand what the stock volatility will be, and possibly forecast the future of the company.
Additionally, due diligence includes analyzing revenue and profit margin trends. This part of due diligence is imply understanding whether a company is growing or shrinking, its an essential part of due diligence and investors should take note of these trends as well.
Companies such as Corporate Resolutions are skilled at conducting due diligence investigations.
Businesses Absolutely Need to Conduct Due DiligenceInvestigations
You wouldn’t buy a car without first researching all the details about it. You’d research the make, the model, the safety ratings, the company’s reputation etc. Equally, investing in a business is expensive. Due diligence is important for businesses to conduct so that they understand the amount of responsibility they are taking on.
At the basic level when buying a company, it’s imperative to understand everything about the company. Every financial record should be reviewed, customer base analyzed, future projects double checked, no stone should be left unturned.
In fact, it is the fiduciary duty of a company to conduct due diligence investigations. A responsibility that companies can ill afford to not perform.