Executing due diligence in any business interaction is a cornerstone of guaranteeing a mutually beneficial relationship.
Due diligence is necessary to determine an individual’s trust and creditworthiness, which will tell you if a business transaction is worth completing.
Failing to perform your due diligence will open you up to risk and liability, which is foolish because these dangers are easily avoidable. It will certainly require extra time and effort, but exercising due diligence will be well worth it for the peace of mind you’ll gain from knowing that you’re doing business with the right partner.
We’ll explain the importance of due diligence below so you can remember to implement it before completing any significant business transactions with new parties.
How Does Due Diligence Relate to Business?
Due diligence is a term that applies almost exclusively to business.
The definition of due diligence is to conduct research or investigate a potential business partner or investment to ensure accuracy and verify that the other party is trustworthy.
This is particularly important when it comes to investing, acquiring another company, or beginning a relationship with a new business partner.
Anytime you’re dealing with a new, unknown party, it’s important to do a full check on them to make sure that they’re someone you should be doing business with.
This involves an investigation of their financials, analyzing their potential, comparing them to competitors, scrutinizing anyone involved with them, and evaluating the risks they carry.
Let’s take a look at the primary reasons for conducting your due diligence.
Know Who You’re Working with
First, you want to have a crystal-clear understanding of who you’re working with.
Are they trustworthy? Has everything they’ve told you checked out? Are they facing any lawsuits? What’s their reputation like?
These are all important things that you’ll discover during the process of due diligence. Entering into a relationship with a new party can be lucrative, but it can also be quite risky if you don’t know their history.
Imagine buying something expensive, like a boat. Don’t you want to work with a reputable seller to avoid getting scammed and make sure that you’re buying a quality product?
That’s one of the greatest aspects of due diligence; it tells you how reputable the other party is.
Minimize Possible Risks
Another reason for due diligence is to minimize the possibility of risk.
Imagine learning that a company you want to buy is almost bankrupt. Or that a potential business partner is a major fraudster that has stolen millions.
Failing to complete due diligence in either scenario would leave you in a very vulnerable position. You might incur a mountain of debt or lose years of earnings down the road.
There’s always some amount of risk involved with major transactions, but some risk is unnecessary and avoidable. You don’t want to sabotage your financial health by climbing onto a sinking ship.
Understand Potential Liabilities
Another great reason for due diligence is to understand any potential liabilities involved.
If another company or partner has outstanding debt, then it’s important to know that before working with them. Failing to do so can make you responsible for paying the dues.
Another important situation involves a party dealing with a lawsuit. If you acquire this company, then you may become liable for any penalties resulting from the outcome.
This doesn’t always mean that you shouldn’t work with a party that has liabilities. Instead, it means that you should ensure that they cover the liabilities and don’t leave you on the hook for them.
Due diligence will allow you to identify liabilities and free yourself from being accountable to them before agreeing to anything.
Maximize Opportunities for Growth
The last part of due diligence is being able to maximize opportunities for growth.
If you’re entering into a new partnership or looking to acquire a new company, then you’re likely doing so intending to make money or expand your business.
During the process of due diligence, you’ll be able to analyze what you can realistically expect from working together. While a deal may sound good in theory, digging deeper can tell you a much different story.
Any agreement should be mutually beneficial, so you want to make sure that you aren’t shooting yourself in the foot to give someone else a leg up. Your business comes first and you have no responsibility to bail out another failing party.
Due diligence is a crucial part of business to make sure another party is worth working with. This is particularly relevant for making a new business partner, acquiring a company, or investing opportunities.
The main reasons for conducting due diligence are to understand who you’re working with, minimize your risk in the agreement, identify any potential liabilities, and maximize opportunities for growth.
Without due diligence, poor and costly business agreements would be extremely common. Fortunately, this can be avoided by doing a thorough investigation of the other party you plan to do business with.