Looking to start a new business relationship? Then you may need to do some due diligence... but why is it important, and what exactly is it?
What is due diligence?
Simply put, due diligence can be thought of as another term for background checks.
It's a process that businesses or investors will go through ahead of agreeing to purchase another business or making an investment.
And individuals and businesses may also complete a due diligence process when they’re embarking on a new business relationship – be it with a co-founder, a new employee or even a new supplier.
And, in either case, going through a process of due diligence allows potential partners, businesses, investors et al to learn more about who they're planning on doing business with.
This information is then used to help make a decision. Potential risks and pitfalls can (hopefully) be identified and the commercial or strategic value of what’s on the table can be backed up with evidence.
Unsurprisingly, where mergers and acquisitions or any such large investments are concerned, due diligence is a major step in getting those kinds of deals over the line.
But really, it’s something we should all be doing.
Ahead of signing any paperwork or making any formal commitments to enter into a new agreement, simply taking some time to better understand what you're getting in to and picking up on anything unexpected that may be a concern just makes good sense.
Whether you’re taking on a new director, looking for investment or simply meeting a company for a job interview, everyone can benefit from performing a bit of due diligence. After all, you wouldn’t agree to buy a car or rent a flat without looking at it first.
How to perform due diligence
Now, the intensity of any due diligence will ultimately depend on the value of the transaction, what’s at stake and what's potentially at risk. Using some of the examples above, a job candidate scoping out a business they've applied to may be satisfied after performing a few online searches, perhaps going as far as finding some reviews from former employees.
While a business on the hunt for new suppliers may be content with finding some reviews from existing customers, they may want to go one step further and check what industry accreditations they have, or if they're a member of their trade association.
It's not just about expertise... it's about values too
If you’re a social enterprise or your business makes a point of being socially responsible, you may also want to check whether your partners take the same goals as you to heart, or at least know that they're not actively opposed to what you’ve set out to achieve.
Detailed due diligence
On the other hand, the due diligence requirements of large businesses or investors may be very detail focused, as you might expect. Such intensive due diligence would likely include both their requests to review documents, records and financial information as well as a series of further checks to make sure the information they've been provided is accurate.
Buf you’re needing to run a due diligence process to assess a large transaction or investment of your own, it'll likely be worth getting some expert help. Due diligence can be a long and difficult process, especially if you don’t know what information to look or who to get it from.
Angel investor due diligence
As discussed, angel investors, venture capitalists and anyone else making a large investment into your business will be looking into a lot of areas in very fine detail.
Think of those tense scenes in Dragon’s Den where a contestant's knowledge of their business, products and/or services are put on the spot for sustained questioning.
Thankfully, due diligence isn’t quite so stressful (or potentially awkward) but, like those contestants that get a public grilling when their numbers don’t quite make sense, investors won’t be afraid to walk away if you’re not able to provide the information and assurances they require.
So what might investors want to check during their due diligence?
To make sure you’re able to respond to an angel investor’s requests in an efficient and speedy manner, you can do your bit to make sure you’ve got as many of the necessary documents and information both to hand and up to date.
- Be ready to produce copies of any significantly impactful or valuable contracts. This is one of the most important steps of this kind of due diligence process, as these will provide evidence of your business’s obligations. Investors will likely want to see documents relating - but not limited - to the following… customer contracts, loans and other credit arrangements and even your employment contracts.
- Another important part of the process investors will likely zero-in on is intellectual property (IP) protection. Ultimately, if the IP is what's drawing investor interest in the first place, then their decision on whether or not to invest will likely depend on your ability to display your ownership or access to it. Not only that, but well-protected IP can help you show your business’s responsible approach to the IP it produces, as well as being a sign of good management.
- Investors will also be interested to see your records from board level. From your articles of association (i.e. the rulebook for your company) to your registers (also known as your statutory books that limited companies must have in place) and even the minutes from your board meetings. Many businesses fail to keep these records and registers up to date, which can lead to a bit of a pinch point during the due-diligence process.
This is by no means an exhaustive list but hopefully provides a flavour of the level of scrutiny your business can expect to be subjected to.
And let’s not forget that, even after you've provided the information that the investors have asked for, it'll likely be subject to further checks and you may need to provide more background for the investor’s due diligence team at their request.
Co-founder due diligence
So, we’ve covered being the subject of a process of due diligence, but what types of checks should we be doing on job candidates, co-founders and potential business partners?
Bringing someone into your small business can be such a big step, it can be time-consuming and by no means a small financial undertaking... so, unsurprisingly, due diligence in this area is common.
Finding the right person is just the first step and, assuming you've done so, you’ll want to make them a conditional offer until you've had the opportunity to carry out the necessary research.
Most of us will be familiar with this concept. We’ve probably all provided names of our past employers to act as our references for the company we’re hoping to work for.
And the process is really not much different for finding a suitable co-founder. In the same way as when we hire employees, you’ll want to assess a co-founder’s level of experience, their knowledge of your chosen industry and how their skills will compliment your own to benefit the business.
Again, it's not just about proof of skills... will you work smoothly together?
Likewise, it’s important that they’re a good fit with you personally and share the same enthusiasm and work ethic...
Do they buy into the look and feel of the brand?
Do they share the same ideas and aspirations as you?
It’s important to get the answers to these types of questions and find the peace of mind they provide before you embark on a working relationship with anyone, not just co-founders.
One way to do this is to rely on the traditional reference/referee approach – but it’s becoming harder to receive comprehensive references from past employers, particularly in light of added responsibilities surrounding an individual's personal data.
If that’s the case, you should turn to your professional network to see if you can find any additional references from there. Failing that, you can always fall back on LinkedIn and try to find someone to reach out to through that network.
Of course, some people may be reluctant to carry out their due diligence exclusively through social media platforms, and rightly so. Information we find online may not always be entirely accurate, reliable or up to date. If you’re carrying out checks on a potential job candidate this way, you may also be opening yourself to discrimination claims if you end up taking something into account you shouldn’t do when trying to make an unbiased decision.
We share some more tips about how to find the answers to these questions, and others, in our guide to performing checks on a candidate or co-founder.