Overview of due diligence

- Do you ask questions when you buy something expensive? I know I do. Think about a car. You might ask quite a few questions. When you're buying a house, you'd ask even more. Now, imagine your company about to spend millions of dollars buying another company. You'd be asking a lot of questions. Am I right? Of course, I am, and this is called due diligence. Some describe due diligence as an investigation. Some would say it's an audit. It's very similar to an audit but there are big differences, like the fact that due diligence doesn't necessarily have to follow the accounting rules of an audit and it doesn't need to conform to generally accepted accounting principles or GAAP. Due diligence is an evaluation of a company often done when making an acquisition doing a merger, or before doing an IPO. It's a process of asking questions about a company's financials and digging into their business processes. Since you're considering buying or merging with a company you're trying to evaluate whether it would be a good company to buy or take public and have trade on a stock market. As you can tell when it comes to due diligence the stakes can be very high and there are a few common players that will engage in due diligence projects. First, you have corporations making acquisitions. This could be when one firm buys another. When Facebook bought WhatsApp you can bet they performed due diligence. If you're doing due diligence, for example for a large furniture store chain that wants to buy a small furniture store chain you can bet that before the deal goes through the square footage of every store the number of forklifts and even the number of nightstands, mattresses and lamps shaped like unicorns will be checked and double checked. Second, you could have a merger. This is when two companies merge to become one. Examples include when big publicly traded stock companies like American Airlines and US Airways merged. That was a multibillion dollar deal. Of course, mergers can also include smaller public and private companies. For an airline merger, for example each company would want to make sure that the number of planes the other has is correct. Third, you can have private equity firms, which are a type of investment firm performing due diligence. They often buy companies that are what's called distressed. That means the companies the private equity firms are buying are losing money. An example would be when private equity firms bought oil and gas companies when oil prices crashed in 2014 and 2015. Good due diligence is especially important for private equity because the returns on each investment need to be very high. Fourth, you might have a bank issuing bonds for a company or helping that company to go public. You can bet that the bank's analysts will perform due diligence before supporting a bond or stock issuance. Fifth, and finally, you have consulting firms that can stand in for the other four parties that perform due diligence. McKinsey and other major firms do these projects rapidly. This is especially important for private equity deals. There are even specialized teams that focus on this in some of the biggest bulge bracket consulting firms. Just like in an audit a due diligence project known in shorthand as DD or a due duli is about checking important facts. There may be different parties that perform due diligence projects but they all have significant financial interests in making sure that they know everything they can about something they're buying, evaluating or promoting to financial markets.