Due diligence, what it is and why

Miljo_04Due diligence is often associated with endless amounts of faded copies of legal documentation, poorly sorted in binders for the review of the advisors of an inclined purchaser, not rarely  under strict time limits. The term in its original sense refers to the care a reasonable person should take before entering into a transaction with another party. The use of the term in its modern corporate finance context, where it refers to the research and analysis of a company performed prior to an investment, is likely attributable to section 11 of the US Securities Act of 1933, according to which directors, underwriters and auditors responsible for the content of a registration document (corresponding to a European prospectus) prepared in connection with a securities offering who is facing potential civil liability for omission and misstatements in the registration documents can claim “due diligence defence” by proving he/she had, after reasonable investigation, reasonable ground to believe that there were no misstatements or omissions in the document.

Due diligence thus refers to the process of, with reasonable care, verifying that certain statements made are in fact correct. In a M&A or private placement situation, the due diligence functions as a risk allocator, where the purchaser/investor is protected for any deviations from what is stated in the warranties, provided that the deviations would not have been discovered prior to the transactions should the purchaser/investor have acted with due diligence.

In practise, the due diligence is the investigation of a company’s critical documents, structures and operations and may include legal, accounting, financial, operational, environmental and other issues. External consultants are normally retained to assist in the review, which may include review of documents, site visits, and interviews with key staff.

For more information, please contact Tobias Bergström.

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