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Due Diligence: What you need to know

Due Diligence: What you need to know

Tuesday 09, 06 2020
When an investor is interested in a business or consider acquiring or merging (M&A) with another entity, serious research and careful review before making the deal will give the investor confidence to be in better negotiating position.

One of the basic reasons for the failure of investment as well as M&A deals is the lack of business information. Due Diligence (DD), which is normally understood as in-depth evaluation, will provide the most accurate data about the operation and efficiency of the business, so that investors can determine the value of a business, and identify visible or potential risks they may face.

What is Due Diligence?

The term Due Diligence had been used as a common word with the meaning of "a necessary effort" before the 15th century. In addition, Due Diligence also meant homework. Over the centuries, the meaning of this term has gradually been changed and it has become a common legal and economic term.

This term is officially used in the Securities Act 1933 of the United States. Accordingly, it is used to indicate "a reasonable investigation and appraisal" to apply to brokers who did not provide sufficient information to investors about their stock sales.

Initially, this term was used only in a limited number of cases of securities or stock trading. But over time, it has gradually been used for both acquisition and merger activities.

Nowadays, Due Diligence is a technical term, understood as the detailed examination of a company and its financial records, done before becoming involved in a business arrangement with it, according to the Cambridge Dictionary.

Thus, it can be basically understood that Due Diligence is an investigation about a business or an individual before signing a contract.

Why Due Diligence?

Due Diligence is an essential element for successful trading. So, what is the reason for conducting Due Diligence? Before acquiring a business, Due Diligence allows investors to assess the value of the business and verify business related information to determine whether or not to acquire it. Due Diligence also allows investors to determine if there are any barriers or risks associated with the transaction. 

Due Diligence normally lasts for no more than one month, but it can vary depending on the complexity of the transaction and can also be extended in some cases. Normally, buyers and sellers will enter into confidentiality agreements before the Due Diligence appraisal process begins. This is to ensure that the information received and evaluated by investors is restricted. Most of the information required to implement Due Diligence is taken directly from the seller.

Due Diligence also provides investors with information to assist them when it comes to negotiation. Due Diligence results may indicate that specific consent is required or may cause the buyer to request specific representations and warranties outlined in the definitive agreement, or some additional compensation accounts given by the seller. If you are buying a property or business, it is important to ensure that Due Diligence is conducted sufficiently and thoroughly.

Due diligence, if properly conducted, will provide buyers with a full understanding of what they are buying and analyze any risks associated with what is being purchased, resulting in a successful transaction without any risks.

Due Diligence: What you need to know

Due Diligence in Vietnam

In fact, in Vietnam, many small and medium enterprises do not have clear financial, accounting and legal activities.

The Shark Tank (a reality show) is a good example of Due Diligence. Season 1 of the show ended with a lot of potential startups who were successful at getting funds from the Sharks. However, in actuality, only 7 out of 22 startups promised to be invested really received investment. Others, due to the failure to guarantee conditions from the Shark during the Due Diligence process, were not funded.

A similar story occurred at the same game show in Australia. Shark Steve Baxter revealed that very few businesses have passed the Due Diligence stage. Among 50 businesses calling capital, 27 received investment proposals and only 4 actually raised capital successfully. To explain this, Baxter acknowledged the lack of transparency of Startups when valuing the company.

Thus, it can be seen that Due Diligence plays a very important role in deciding the success or failure of an investment or M&A deal.

Key factors leading to success in due diligence

Henry Tran - VietnamCredit


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