UK Accounting Glossary
Due diligence is the effort a party makes to avoid harm to another party. Quite often a party in a contract may be obligated to provide due diligence.
An example of a “due diligence report” is a Phase I Environmental Site Assessment (ESA), which is performed to determine potential environmental conditions that may cause harm to the surrounding environment.
Due diligence is a formal investigation into any proposed investment. That investment can be a security, private equity capitalization, acquisition, merger, or any other contract. The term “due diligence” finds its roots in Section 11 of the U.S. Securities Act of 1933. Although the Act does not mention “due diligence,” it stipulates that as long as an investment professional carried out and communicated the findings of due diligence on the securities they sold to private investors, the investment professionals could not be held liable for investor losses. Today due diligence is carried out by investors to find out whether the proposed investment is all that it claims to be. Due diligence into an investment may include enquiries into its real stock worth, management team, financial history, financial health, outstanding litigation, short-term and long-term processes, physical assets, strategic partnerships, credit status, revenue growth, valuation, and dozens of other legal and financial barometers. Due diligence usually falls to the investor or buyer, but sellers also do due diligence on buyers. For example, a seller may want to find out whether the buyer has the financial backing necessary to complete the transaction. Due diligence seeks to ensure that all parties have a comprehensive understanding of the quality of the investment.
In finance, for example, the term can refer to the activities of pension or investment fund managers in keeping track of the operations, solvency, and trustworthiness of the managers of a corporation in which their fund is invested, or those of the managers of an acquiring corporation toward a target corporation.
A “due diligence report” is often prepared to discover all risks and implications regarding a decision to be made. Information may be gathered by the due diligence team either by external analysis and research as is typical during due diligence for venture capital funding or information may be formally laid out using a secure data room used in due diligence for mergers and acquisitions.
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This glossary post was last updated: 9th February 2020.