We use the term ‘due diligence’ as a euphemism for doing one’s homework in a business or legal sense. But to people in the business world, it has a more concise definition. In addition, there are very specific reasons for conducting it.
Due diligence could mean the difference between a successful acquisition and an epic fail. It could mean the difference between making money on a startup or losing your shirt. Even single investors looking at new stocks or fund opportunities undertake due diligence.
So why do it? The reasons may surprise you. Some of those reasons are discussed below, compliments of DaaS provider Mezy. Mezy is a Utah business specializing in competitive analysis, due diligence reports, valuation reports, and more.
Reason #1: To Understand How a Company Operates
As a business practice, due diligence refers to investigating all the finer details of a target company. One of the chief reasons for doing so is understanding how the target company operates. On the surface, company operations may seem fairly simple. Yet very few businesses are as simple as they appear.
Running a business is complex. It has endless moving parts that are influenced by market conditions, regulations, financials, and more. Comprehensive due diligence analyzes the inner workings so that investors can have confidence before they spend their money.
Reason #2: To Understand the Company’s Potential
Due diligence is applied to startup investing. It is applied to private equity, mergers and acquisitions, and even individual investments. The one thing they all have in common is potential. Investors invest because they want to make money. It is no more difficult than that. Therefore, a big part of due diligence is determining whether or not the potential to turn a profit exists.
Potential can be measured strictly in dollars and cents. But it can also be measured in other ways. There may be potential in patents and trademarks. There may be potential in untapped intellectual property. The possibilities are endless.
Reason #3: To Determine Current Value
One of the reports Mezy furnishes is known as the valuation report. Its purpose is to more or less analyze the target company’s current market value. Investors obviously want to know this. Like anyone else, they want to know they are getting a good deal before they agree to move. There is no point in paying too much.
Reason #4: To Uncover Legal Ramifications
Companies looking to make mergers or acquisitions rely on due diligence to uncover legal ramifications. What might those ramifications be? They can be anything from past litigation to pending court cases to the potential for future lawsuits. There are also legal ramifications pertaining to trademarks, patents, intellectual property, and so forth.
Reason #5: To Examine the Target’s Financials
Finally, investors utilize due diligence to look into a company’s financials. They want to see that the target is on sound financial footing. And if not, they have to know what it will take to get the target in a good position. If financials look weak, investors have to seriously consider whether or not investing is worth the risk.
Note that financials are distinct and separate from value and potential. A company can have a decent valuation but still be on shaky financial ground. In this regard, due diligence looks at everything from current debt load to future revenues.
Now you know why due diligence-as-a-service exists. You know why investors and companies conduct due diligence before investing in new opportunities. If not for the due diligence process, a lot of expensive deals would be made blindly. That is no way to conduct business.