Due diligence investigation is an intensive and exhaustive activity, and many types of due diligence can apply. The importance of each type of due diligence for a particular transaction will vary according to the industry and the type of transaction. 
 
When done properly, each type of due diligence is as valuable as the next and will support and inform the others for an integrated approach. Ultimately, all the different examples of due diligence have the same end goal. They provide businesses with the information they need and the confidence that the transaction is worth pursuing.

What is due diligence?

Due diligence is a comprehensive assessment of a business undertaken ahead of a major event, such as a merger or acquisition, exit, IPO or capital raise. This thorough process surfaces the risks and opportunities of proceeding with the purchase or investment and helps to determine if an acquisition or investment is a good fit. 

Before the due diligence process can take place, the target company must gather a huge amount of information across all areas of the business. Conducting due diligence requires looking at past and current performance, confirming the accuracy of reports, and assessing whether a transaction – such as investment or the purchase of a business – is viable.

What are due diligence documents?

During a business transaction, such as a corporate merger or securities purchase, due diligence documents play a crucial role. These documents encompass various categories, including legal, financial, sales and marketing, and human resources. Through meticulous research and analysis, due diligence documents provide invaluable insights into a company or organization, enabling informed decision-making and mitigating potential risks.

Who conducts due diligence?

Due diligence is conducted by parties looking to invest, such as equity research analysts, fund managers, private equity fund managers and companies considering acquiring other companies. External advisors, including accountants and legal teams, are often involved in due diligence processes. 

What is involved in due diligence?

Due diligence examines the business’s numbers, comparing the figures to industry benchmarks and tracking trends over time. It’s an opportunity to identify areas for improvement and track performance. Due diligence also includes thoroughness in activities like background checks to verify information from employees or suppliers.  

12 types of due diligence in business

Due diligence types can be broadly divided into hard or soft due diligence, categorised by the nature of the material being assessed and evaluated. 

Hard vs soft due diligence

Hard due diligence deals with material things that can be assigned a clear monetary value (the numbers), while soft due diligence considers the aspects of a business that are harder to pin down to a dollar value (people, culture, relationships, market sentiment etc). 

Hard due diligence is the assessment of the quantifiable numbers that matter in a business, like where the money is, where it goes, the tax liabilities, legal status, operational state, administrative details, assets and intellectual property. 

Soft due diligence assesses aspects of business like market positioning and market share of a company, the culture and management, relationships with suppliers, customer sentiment, partners and human resources. Both of these categories play a key role in preparing for a merger, acquisition, capital raise or planning an exit. 

Each of the types of due diligence outlined below will have some overlap with each other, and not every type is required for every situation. This list gives an overview of the different types, and while not exhaustive, it reveals the depth of assessment required. 

7 types of hard due diligence

Financial due diligence

Financial due diligence is one of the most important types. It seeks to validate a company’s financials through in-depth analysis of the financial statements, tax filings, capital expenditure, audits, customer accounts and cost analyses. It also assesses the debt and considers financial projections. The goal of financial due diligence is to reveal the current state of the company finances, assess past performance and identify risks and opportunities.

Financial due diligence is the most likely type to appear and it’s often done by accountants or a financial advisory team. 
 
It goes beyond the statements provided in annual reporting and looks at the underlying financial health of the company, to provide investors, potential buyers or potential partners with a comprehensive picture of the company performance. 

Legal due diligence

Legal due diligence ensures a company’s legal, regulatory and compliance status. This includes reviewing contracts, corporate documents, board meeting minutes, any pending litigation and intellectual property rights. The goal of legal due diligence is to assess any risk and to investigate any potential liabilities of the company that could impact a successful investment, transaction or partnership.

Legal due diligence is conducted by lawyers on both sides of a transaction or raise. 

Tax due diligence

Tax due diligence, also known as fiscal due diligence, examines all the different tax liabilities, compliance with tax law and any pending tax-related cases. It includes reviewing tax audits and tax returns.
 
Examples of tax due diligence are the validation of documents like tax returns (usually for the last three to five years), information pertaining to tax audits, and agreements with tax agencies. It aims to ensure all the company’s taxes are being paid and reported. This process provides peace of mind and certainty for investors and buyers. 

Operational due diligence

Operational due diligence evaluates operational risks and processes, including the operating model, assets, products and services, technology, supply chain, sales and marketing. 

For M&A buyers and potential investors, operational due diligence assesses whether operational improvements could create additional value in the transaction, or if there are operational risks that should be addressed.

Intellectual Property due diligence

Intellectual property due diligence is the review of a company’s intangible assets, including patents, copyrights, trademarks and brand names. Intellectual property (IP) can account for some of a company’s most valuable assets, so it’s an important consideration.  

IP due diligence also considers how well these assets are protected and covered in the relevant jurisdictions.

Information Technology due diligence

IT due diligence is an audit of a company’s IT infrastructure and processes, frequently with a focus on security assessment. This type of due diligence allows the acquiring company to evaluate existing IT structures and identify any potential security risks. Among other things, this includes how sensitive data is managed and protected.

Regulatory compliance due diligence

Regulatory compliance due diligence assesses regulatory or compliance issues, and is particularly critical for heavily regulated industries, including health care and finance.
 
It’s crucial that companies undertake regulatory due diligence to identify areas of legal or regulatory risk that usually have a zero tolerance policy. This type of due diligence may have some overlap with legal due diligence, however specific industry knowledge of the applicable compliance risks will add value to the process. 

3 types of soft due diligence

Commercial due diligence

Commercial or market due diligence investigates the company’s market share, competitive positioning, future prospects, growth opportunities, supply chain, sales pipeline and R&D pipeline. It may also consider management, human resources and IT. 

Commercial due diligence aims to assess if the company is financially viable and the likelihood of realizing value from an investment or acquisition.

HR due diligence

HR due diligence analyses the organizational structure, compensation and benefits of employees and management, vacancies, union contracts and any HR-related disputes or issues. This may include work health and safety (WHS) and overlap with legal due diligence. All HR policies and procedures are also carefully assessed.

HR due diligence  can help to identify any people-based risks before proceeding with a transaction, such as the likelihood of key roles exiting the business.

Environmental due diligence

Environmental due diligence evaluates an asset, property or business to understand and manage potential risks and obligations. It means knowing the environmental regulation that applies and also meeting ESG standards. This systematic assessment considers contamination and pollution risks, permits and licences, as well as the values of the company and internal targets for environmental stewardship. 

This type of due diligence is important for industries like mining or oil extraction, as risk of non-compliance can result in heavy penalties or shutdown. 

Two types of bespoke due diligence

Confirmatory due diligence

Confirmatory due diligence is a critical phase of M&A due diligence and it can determine the success of failure of a deal. Once a Letter of Intent or term sheet is issued, confirmatory due diligence begins to verify the assumptions made during preliminary due diligence and uncover any issues before the transaction can be finalised. 

This type of due diligence reviews all of the due diligence undertaken up-to-date for the particular transaction, covering many types of due diligence, from financial to HR and regulatory compliance. 

Specialized due diligence

Specialized due diligence refers to the thorough investigation and assessment of specific areas or aspects of a target company beyond the standard due diligence process. 

While standard due diligence covers various aspects such as financials, legal matters, operations, and market analysis, specialized due diligence dives deeper into particular areas that are critical to the success of the M&A deal.

Preparing for the due diligence process

Due diligence can occur early in a deal or once an in-principle deal is agreed, but before a binding contract or investment is finalised. The company subject to due diligence is obliged to disclose accurate information and answer questions posed by the investors or bidders. 

Being well-prepared positions a company for a successful transaction. Complete documentation and the ability to answer every question will maximise the valuation and sale price by streamlining the process to capture optimal value.

How prepared are you? Take the five-minute readiness assessment. 

Power multiple types of due diligence with AI 

Due diligence puts a microscope on every aspect of a business, and for companies under scrutiny, there’s a lot of data to surface and documentation to prepare. Fortunately, businesses can power due diligence with AI to streamline the preparation process and ensure control over documentation in a shared environment.
 
Using a secure, AI-powered data room, due diligence is more efficient, with tools trained on thousands of transactions to analyse interactions between parties and parse enormous volumes of information. Surfacing value from thousands of data points and automating hours of work, like redaction, is a clear way to reduce due diligence costs and ensure traceability of each document. 

 

FAQ

What are the main types of due diligence?

While there are as many as 12 different types of due diligence in business, they generally fall into three broad categories:

• legal due diligence.
• financial due diligence.
• commercial due diligence.

What are the 4 Ps of due diligence?

The 4 Ps of due diligence are People, Performance, Philosophy and Process. These key elements are the foundation of a robust due diligence process, covering aspects relating to the team and business structure to performance, processes followed, philosophy and strategic direction.