Due Diligence – Types, Process & Importance

December 26, 2023    commerciallawyersinperth
Due Diligence – Types, Process & Importance

Due diligence refers to the act of compiling and assessing documents and information involved in a contract or a deal before the concerned parties sign it.

Alternatively, it refers to the efforts individually taken to examine and meet the requirements of the concerned contract or agreement. It involves a thorough assessment of the pros and cons, liabilities and assets, risks and rewards of an agreement or contract.

Due diligence can be classified into various fields depending on the subject of the contract. It ranges from environmental due diligence to financial, intellectual property and more. Any examination of a material contract requires due diligence.

What is due diligence?

The term due diligence is commonly used in day-to-day life to refer to any careful or persistent effort expected from an individual or a situation.

Hence, as the name and its meaning suggest, this act of diligence must compulsorily precede the decision-making stage for contracts and agreements. In other words, due diligence is the responsibility of any reasonable organization or person before agreeing.

This requires detailed records, explanations and Commercial Contract Clauses made transparent and clear to all parties involved in a contract.

Due diligence is performed so that during the signing of the agreement or the purchase, there is full informed consent from the parties involved. This way, the rights of the parties are informed and protected from potential mishaps, hazards, torts or frauds.

Types of Due Diligence –

While due diligence is applicable in any field involving an agreement or contract, it can be classified into three major types:

1. Financial Due Diligence:

This is concerned with looking at a company or business’ finances, assets, liabilities, profits and losses, income and expenses. This is done to assess and validate the health of the financial and business model.

2. Legal Due Diligence:

As the name suggests, this involves looking at matters of legal compliance in employee contracts, rights, intellectual property and potential litigations.

3. Operational Due Diligence:

This examines the function and operations of a company to assess and validate the sustainability of its business model based on the way the company operates. Looking at management, human resources, IT, production, etc, are part of the assessment process.

What is the process of due diligence?

In Australia, due diligence involves informing on legal structures, titles and shares of a company or business assets, real or intellectual property, financial contracts, material contracts, healthcare, terms and conditions of use and ownership when it comes to information technology, agreements for employees, material litigation and matters of legal compliance. These are some of the broad areas of due diligence most commonly encountered.

However, the process of conducting due diligence covers similar bases for all types. Legal due diligence primarily ensures a company’s contracts, rules, and agreements comply with the state’s legal and regulatory framework. This involves checking for pending litigations, intellectual property, contracts, and audits.

The steps involved in this sort of examination are explained below:

1. Preparation of the report:

As the name suggests, preparation involves preparing an audit or report of the clauses involved in a contract or an agreement. This involves compiling the information and setting up objectives for the agreement.

2. Inspection:

This is the step where a Due Diligence Lawyer Perth examines the audit, report or contract. This involves going through the clauses and the terms and conditions. At this stage, the lawyer suggests corrections or advice on the potential assets and liabilities, risks and rewards. The lawyers also inform the buyers about agreements to be upheld and their responsibilities if they agree to the contract.

3. Deduction:

This is a conclusive step where all the previous investigations and examinations are used to present a realistic scenario about the rights, assets and liabilities, profits and losses of the parties involved in the contract. This step empowers the buyers and the parties involved in the contract and enables them to make informed consent.

Importance Of Due Diligence

  • The importance of due diligence is to manage and mitigate risks during any contractual agreement, transaction or merger and acquisition.
  • It prevents the possibility of loopholes or the chance to overlook any important clause and the lack of compliance, which could result in legal troubles. It also prevents any scope for making decisions uninformed. For example, during a Merger and Acquisition, also known as M&A, a lawyer will advise the buyers or investors on the pros and cons and the expected profit or loss to be incurred from investing in a company during the process of its acquisition.
  • The legal team can also ask for further information if they are not adequately represented in the contract. This is done with the interest of protecting the rights of the buyers and providing full transparency. This is on the part of the buyer’s due diligence.
  • In the case of the seller, due diligence is performed to spot “red flags” or cases of potential exceptions when it comes to auctions or bids and prevent scams and frauds. While a buyer’s due diligence tends to be more thorough than a seller’s, the latter’s report can help prepare the buyer’s diligence audit and influence their decisions.
  • Further, thorough due diligence can prevent a company from bankruptcy or corporate insolvency. This is especially relevant for Australian companies that appeal to investors from all over the world to conduct business here. The solvency of new business endeavors can be greatly improved through due diligence.

As previously mentioned, informed consent, right to information and risk management are the primary rationale behind due diligence.

Parting words –

Due diligence is foundational in any new endeavors, business or personal alike. Good due diligence can be the difference between a successful business model and years of legal trouble and potential lawsuits for compliance.

As a result, it is important to have knowledgeable and seasoned lawyers assist in the process.

We recommend the best due diligence lawyers Perth to our clients to ensure their rights are protected, and their cases are well represented. Find the best commercial lawyers Perth with us to quell your concerns and mitigate risks during your new business endeavours.

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