Due diligence is often viewed as the collective assessment checkpoints associated with transactions like mergers and acquisitions or funding endeavors. While these are certainly common pairings, due diligence can also be extremely helpful in assessing the overall health of a business and other factors. Essentially, due diligence is defined as “the investigation or exercise of care that a reasonable business or person is expected to take.” That definition may be followed by “to satisfy legal requirements” or “before entering an agreement,” but can and should be followed more generally by “before making any highly important business decisions.”
More than an audit that simply takes inventory of current practices, due diligence can be thought of as a comprehensive assessment of core business areas to provide company leaders with the information necessary to make an informed business decision. Despite its inherent value and importance for leaders, due diligence is frequently shadowed in ambiguity and can find leaders without a clear idea of where to start, or which areas are most important for them to examine. Below, we’ll examine a simple four-part framework that leaders can follow for a straightforward due diligence process that covers the most important performance areas of an organization. And in upcoming blog posts, we’ll dive deeper into each of these four core areas.
Four-Step Framework for Due Diligence Assessments
As the Corporate Finance Institute notes, there “can be as many as 20 or more angles of due diligence analysis,” from administrative to taxes to environmental, and more. This depends on a variety of factors, including the perspectives of those carrying out the due diligence process and the type of transaction, decision, or assessment the process is supporting. The four components below examine primary pillars that affect a business and can encapsulate many secondary areas as well.
Perhaps one of the first areas that come to mind when considering due diligence, the financial elements captures and examines every aspect of a company or asset’s financials, including but not limited to financial statements, cash flows, balance sheets, and budgeting. Also, financial due diligence may examine current customer account profitability as well as the sales pipeline for an objective look into forecasts and profit potential. When assessed accurately, this can serve as an objective route for uncovering deeper structural gaps, opportunities for improvement or areas that should be addressed now to prevent issues down the road.
The People area of due diligence can be quite extensive, exploring all aspects of a workforce, from current roles to company culture to HR and potential red flags. You may even hear this element referred to singularly as HR due diligence since it often includes taking inventory of current HR policies, employment contracts, health benefits, welfare insurance and any pending or potential labor disputes. It can also include examining the organizational chart to assess team dynamics and optimal areas of responsibility. And while culture is not a purely quantifiable metric, it is a deeply ingrained, pervasive aspect to be aware of (or prepared for). This area of due diligence seeks to deliver an accurate appraisal of the current employee base, where their expectations lie and any areas that need immediate addressing.
Not surprisingly, legal is an important component of most due diligence efforts and commonly rolls in risk evaluation and other related factors as well. While legal due diligence will vary across industries, organizations, or even departments, a solid place to start is with a compliance audit to determine overall adherence to governing policies and related industry regulatory guidelines. Company and employee contracts, indemnification processes and intellectual property details should all be included in your scope of examination, as well as a review of tax liability verification. Ultimately, legal due diligence is a proactive approach for identifying and preventing prospective litigation issues within a company, organization or department.
Finally, Operations encompass all the activities and materials required to keep the company, organization or department “up and running” for the short-, mid- and long-term. Operations is deliberately vague here, as the scope of operations due diligence can vary significantly depending on the organization or group you are reviewing. Nonetheless, admin-related items such as facilities, equipment, processing costs, and reconciliations are all viable considerations for operations due diligence. The objective here is to acquire a deeper understanding and verification of the organization’s operations as it relates to operational costs, systems, inventories, policies, processes, and practices.
Objective Assessment for Insight and Action
Again, due diligence can take on many forms and there is no single path that is best in all instances. With that in mind, applying this four-part framework for your business will arm you with a reliable and flexible tool for evaluating the health of the organization and that many elements that comprise it through an objective and comprehensive lens – one that delivers the insights you need to make well-informed business decisions and confident transactions.
Have more questions about using due diligence to assess key aspects of your business and inform actions? Request a complimentary consultation with a vcfo expert today.