Due Diligence is a comprehensive investigation of a potential transaction prior to entering into or completing an agreement. It can involve reviewing all financial records, plus anything else deemed material. It’s all about the care that should be taken before entering into an agreement or a financial transaction with another party.
Due diligence can involve an investigation of a buyer by the seller, such as whether they actually have the resources in hand to finance the sale or if they are full of s*it.
Due diligence can be done by companies looking to make an acquisition, by equity research analysts, by fund managers, broker-dealers, and of course, by investors. For individual looking to invest, due diligence on a security isn’t required but it is recommended. Broker-dealers, however, have to conduct due diligence on a security before selling it.
Due diligence became common practice with the passage of the Securities Act of 1933. The act says that securities dealers and brokers need to disclose all relevant information about what they are selling before they sell it. Not doing so can lead to criminal prosecution, and no one wants that.
The Act does include a legal defense for the dealers and brokers that basically says as long as they did their “due diligence” before selling and of course fully disclosed their results to investors, they would not be held liable for information not discovered during the investigation phase.
When a startup is preparing for their initial public offering (IPO), a due diligence meeting is standard. This is a careful investigation that ensures all material information relevant to security issue has been disclosed to prospective investors.
Of course we’re going to exercise due diligence before selling our company. We would be fools not to, and also, we’ve got nothing to hide.