What is Due Diligence, Why it is Important, and How it Works and, What it Does ?

What is Due Diligence?

Many of us would have heard the term Due Diligence in various contexts and situations where one party to a transaction often tells the other to do their due diligence or states that it is considering the same.

Indeed, as anyone who has negotiated an employment contract or a legal drafting of terms and conditions would have come across the term Due Diligence. So, what exactly is due diligence and how it works and why it is so important in the corporate and legal contexts?

To start with, Due Diligence is a way of ensuring that the terms and conditions outlined in any contractual deal are legally favorable to the concerned party.

Whether it is a real estate deal, hiring contracts, employment contracts, or tenders and bids by private parties, due diligence is done to protect oneself from the legal troubles that can ensue if the contract is unfavorable to a particular party.

Thus, it has become a standard practice for all contracts in corporate and other organizations to be put through a vetting process where each party considers if the terms and conditions are favorable to it from both a legal as well as commercial standpoint.

Why is Due Diligence Done?

Indeed, the term commercial advantage is equally important as due diligence of prospective contracts is done to ensure that a particular party is not getting the Short End of the Stick or in other words, is not being cheated by the other party.

Apart from the legal vetting, most parties to commercial contracts often do transactional and economic due diligence wherein they study the prospective deal from the point of view of whether it would be beneficial to them both in the shorter as well as longer terms.

Thus, mergers and acquisitions by businesses are often put through the due diligence process wherein the firm considering the acquisition of another company often checks to see if the terms and conditions of the proposed merger are favorable to it.

In addition, mergers are usually preceded by due diligence by investment bankers and consultants wherein they read the fine print and go through the assets and liabilities of the other firm as well as ensure that the other firm is indeed profitable and hence, after such diligent study, come to a conclusion as to whether to go ahead with the deal or not.

Why is it Known as Due Diligence?

Indeed, the fact that either party to a deal has to go through the details diligently is the reason why the process is named due diligence wherein diligent study of the contracts is done in a manner that is consistent with the due principle of legal and commercial aspects.

Apart from this, due diligence is also done by prospective clients to corporates as to whether they would get a favorable deal from the other party regarding the commercial and profitable aspects.

Given the fact that culture also plays a part in determining the success or failure of mergers and acquisitions, it has become the norm to do due diligence from a cultural standpoint as well.

Why is it Important?

While such due diligence might not necessarily entail legal aspects, it is extremely important for parties to a deal to consider whether there is a cultural fit between them.

Indeed, with national cultures and organizational cultures being different in global deals, due diligence from a cultural viewpoint has become the norm these days.

Apart from that, cross-border deals are also put through a vetting process to determine whether legal and national rules and regulations are being followed and to find out beforehand any potential violations that can cause problems down the line.

In recent years, there has been a trend wherein job applicants and their prospective employers are doing due diligence on each other mainly due to the high stakes involved in senior positions wherein wrong hiring at such levels can seriously jeopardize the interests of the firms and the employees.

Indeed, due diligence is also being done by the middle manager and even fresh hires since the margin of error for hiring and firing has become so narrow due to the high costs of recruitment and training of such hires.

Due Diligence on a Personal Level

On a personal level, it has also become the norm for prospective grooms and brides to do their due diligence on each other so as to avoid costly divorce suits and other kinds of problems including personal problems.

For instance, just like employers are performing background checks on prospective employees, would be grooms and brides are also checking each other’s backgrounds and whether they are what they say they are.

In other words, the risk of being taken for a ride in marriages is also high since it can lead to expensive divorce and legal suits due to such risks.

Conclusion

Lastly, having considered all the aspects of due diligence, it is our view that it is a very pertinent and relevant process that can be used by anyone and irrespective of the costs of failure since who likes to be taken for a ride whether it is a megamerger or a simple thing like renting a house. Indeed, given the fast-paced nature of society and the costs of failure in time and monetary terms, it is perfectly ok if you do your due diligence before committing yourself to a transaction.

To conclude, you would have probably done the same by reading the first few lines of this article, and we hope it was worth the effort to have read the article fully.