Due diligence is a significant term in the world of finance. Often referred to as an investigation or audit, due diligence implies research and fact-checking of a specific product or investment. Some business parties are bound to conduct due diligence by law (like brokers), while private and individual investors aren’t.
Nevertheless, it is highly recommended for all investors and buyers to conduct due diligence to ensure that their investment goes as planned. More importantly, due diligence will ensure that there isn’t any hidden data that could potentially turn the investment of your life into a nightmare.
On Due Diligence
Whenever a company or an individual seeks to make a new acquisition, it is recommended that they conduct due diligence. Though the company, fund managers or investors can perform due diligence on their own, it is always preferable to hire professionals, due to the complexity of the process.
Though various investigative and research companies have their methods and ways of performing due diligence, it often includes these steps:
- Company Capitalization – this step consists of the formation of a general image of the company and its market value (its worth, revenues, stock exchange, etc.)
- Evaluating Current Margins – taking a closer look at the digits, and checking whether the current margins are rising, falling or stagnant
- Checking Competitors – comparing the company with its competitors is always healthy and brings the more precise image of the company’s current standings (and how successful it is within a specific industry)
- Ratio Examination – this step includes evaluation of P/E, P/S, and PEG ratios of the company and its competitors (always in comparison to other, of course)
- Managers and Shareholders – this step examines the founders of the company, how many shares do managers and owners hold, which institutions hold the float (and what amount), and so forth
- Examining Balance Sheets – checking the debt-to-equity-ratio with regards to the company’s business model, monitoring the cash flow and the amount of debt, and performing similar activities
- Reviewing History Of Stock Price – this is self-explanatory, right?
Importance Of Due Diligence In Private Equity
According to CorporateResolutions.com, private equity can have several definitions and meanings, depending on the person that defines it. However, most will say that it is equity (surprise surprise) that cannot be traded and isn’t publicly listed. Now, because such equity (often represented in the form of shares) isn’t publicly listed, it is already more difficult to get a full picture of it.
Today, PE industry consists of high net players, institutional investors, private firms and pension funds, among others. Due diligence plays a massive role in private equity because it helps determine and create a value of specific equity.
Once investors conclude that they want to pursue a new acquisition, they often hire various “deal breakers” such as investment bankers, analysts, investigators to help close the deal. While the bankers and analysts look into existing reports and help determine whether it is a good idea to pursue a specific acquisition, investigators help to uncover “skeletons in the closet.”
For instance, a company named Corporate Resolutions INC will look into founders, management, investors and vital affiliates. Why? Each party could lead to a more successful deal, or be a deal-breaker, depending on what the investigative firm finds. Companies like Corporate Resolutions INC will also focus a lot on the management’s performance. They will also ensure that the seller’s data is genuine, securing that you, the buyer, don’t experience any negative surprises once the deal is closed.
Is Due Diligence Necessary?
No, it isn’t necessary to conduct due diligence. It is, however, foolish not to conduct it. It’s not just about finding the skeletons in the closet and uncovering deal breakers, but also about finding valuable data that makes the deal even more profitable. Professional investigators will also help uncover potential frauds, criminal behavior and whether the US regulatory agencies have sanctioned the seller.
Though we can’t speak for other firms, the Corporate Resolutions INC will also examine court records, public records, even the social media presence. Moreover, they will examine corporate documents and bankruptcy filings and present and hand over all valuable data to their clients.
Due diligence is like a holy grail of deal-making and is considered as an integral part of not just the private equity industry but the entire financial sector. If you decide to hire investigative firms to aid you in your due diligence process, make sure that you hire someone that is passionate about the due diligence process.
