In my last article on Buyer Beware: 5 Steps to Consider Before Hiring a Small Business Consultant, we touched on the importance of doing your due diligence. Many of you further asked the following questions: What is due diligence? What does it really involve? Due diligence is fundamental to all aspects of business, whether it is large, medium or small business. Larger companies typically hire lawyers, bankers and accountants to help with any due diligence. As a small business owner, you may not have this luxury, and may have to do this work yourself or with limited resources. Let's spend some time exploring what can be involved in due diligence.
Due diligence is proactive risk management. It refers to the care that a reasonable person exercises to avoid harm to either party in a transaction. Stated another way, it is the research and analysis of an entity or individual that is completed in preparation for entering into an agreement or transaction with that party. This research and analysis can involve some of the following questions and steps:
- What do you want to achieve? Define the objectives of the transaction and the objectives of conducting the due diligence. Be as specific as you can as that will help you establish the boundaries for your due diligence process. The last thing you need is to have a process which unnecessarily goes on for months and months because of lack of focus and clarity on what you are really trying to do.
- Do you have a due diligence framework? A due diligence framework is a structured approach to researching the other party to the potential business relationship. This structured approach enables you to determine the informational objectives, boundaries, milestones and timelines involved. We may often ask random questions when researching the other party as opposed to being thoughtful and deliberate.
- As a business owner or leader, you have a million things to do. However, there is value in taking some time to write down and organize the thoughts and questions that you have and that you want to pose to the other party. A due diligence framework carefully sets out what are the steps to be completed, questions to be asked and information to be gathered about the other party.
- When formulating your due diligence framework, there are categories that may be helpful to you in organizing your approach, thought process and questions. Some of these categories of due diligence include: market or commercial, financial, accounting, tax, operational, environmental, regulatory, legal and reputational.
- What is the context? Identify, frame and understand the environment, context and constraints involved with the subject matter, other entity and transaction. This also has impact on the criteria and measures that you establish for your due diligence process.
- What are the metrics? Define the criteria and measures for evaluation that are relevant to the situation and transaction, and that are important to you. This helps to provide mechanisms for you to objectively evaluate the data and inputs and guide your decision making process.
- Have you done your homework on the other party? Educate yourself and acquire knowledge about the subject matter and parties involved in the potential transaction. In other words, conduct your examination of the company or individual that you are considering entering into a business relationship or transaction with. Ask your questions and reflect on the responses and information received.
- Have you performed the critical assessment? Evaluate, cross reference and synthesize all of the data points and environmental factors in the context that you have set. After you have implemented your due diligence framework and process, what do the results tell you? Is all of the information consistent or are there outliers? Are the anomalies reasonable or appropriate given the other party or transaction situation? Does all of the intel that you have gathered make sense?
- Have you employed your judgment, intuition and street smarts? Exercise logic, intuition and judgment in the evaluation process and to make conclusions and decisions. Are you comfortable with all of the information that you have gathered and the direction that the results point you in?
In addressing the above questions and steps, you are conducting a detailed risk assessment. The due diligence framework you are implementing and the research you are conducting enable you to gather information about the people, processes and systems involved in the potential business relationship or transaction being considered.
Completing this process of proactive risk management will help to protect you when considering entering into a business relationship and transaction with another party.
Some constraints to keep in mind in the due diligence process are time, costs and the amount of evaluation required. Data overload can come into play, and that is where intuition, experience and judgment can help you distill and focus on what is important. The nature, scope and extent of the business relationship will impact the level and robustness of the due diligence process you undertake. In other words the more extensive, complex or risky the potential transaction, the more thorough the due diligence process is recommended. Each business owner has to strike the right balance of how much time they feel appropriate and worthwhile to invest in such risk management processes.