Introduction

Corporations make game-changing business decisions every single day. In 2021, over 23,500 merger and acquisition deals closed in the EU alone, with another 23,161 deal closures in the US.

Before deciding to merge with, acquire, or enter into a new venture with another business entity, corporations must conduct a due diligence review to detect potential risks. Without adequate due diligence, companies may subject themselves to massive—and avoidable—legal and financial liability. But a comprehensive due diligence investigation can be very costly. That’s why more and more organizations are conducting due diligence investigations internally.

In this post, we’ll define due diligence and outline its three principles. We’ll then take a closer look at investigative due diligence and talk about when they’re needed and who should be involved. Next, we’ll discuss the challenges and steps of due diligence investigations and set out a few key considerations and best practices for investigators to take into account. Finally, we’ll explore how end-to-end eDiscovery platforms can help corporations efficiently complete in-house due diligence investigations.

Contents

What is due diligence?
The 3 principles of due diligence
What is a due diligence investigation?
What is the purpose of a due diligence investigation?
When is a due diligence investigation needed?
Who is involved in a due diligence investigation?
The most common challenges of due diligence investigations
What is the difference between a due diligence investigation and a financial investigation?
The 3 steps required to perform a due diligence investigation
Best practices: A due diligence investigation checklist
End-to-end eDiscovery solutions streamline due diligence investigations

What is due diligence?

Due diligence is the process of combing through data and documents to identify potential risks before making a major business decision, such as merging two businesses. Due diligence can be geared toward legal, financial, or commercial risks or a combination of all three.

The term “due diligence” has appeared in texts for centuries, from the United Nations’ 1872 arbitration award holding Great Britain liable for maritime damages to U.S. ships to the U.S. Securities Act of 1933. Today, people commonly use the term in business, real estate, and human rights circles around the world.

Regardless of the subject area involved, three main principles govern due diligence.

The 3 principles of due diligence

The importance of due diligence is a common theme in human rights. In 2011, the U.N. published its “Guiding Principles on Business and Human Rights,” which outlines three due diligence principles. These principles apply in the business context as well.

The due diligence principles state that organizations should:

1.     identify potential risks,

2.     prevent and mitigate those risks, and

3.     account for how they address the impact of each risk.

How do businesses put these principles into practice? By performing a due diligence investigation.

What is a due diligence investigation?

A due diligence investigation is a formal fact-finding mission to examine the potential liabilities associated with a business decision. It typically culminates in a cost-benefit analysis comparing the potential advantages and risks of completing a transaction.

A due diligence investigation usually involves a deep inquiry into the history and current activities of another individual, a business, or a property. However, an organization may also investigate itself before pursuing a big change, such as a merger or sale.

A thorough investigation may reveal illegal activities, unethical practices, and other red flags. Alternatively, it may confirm that the subject is trustworthy and that the business transaction wouldn’t pose any serious risks.

While the goals of a particular due diligence investigation may vary, the underlying purpose of the process remains the same.

What is the purpose of a due diligence investigation?

The purpose of a due diligence investigation is to prevent harm. Typically, corporate investigators focus on mitigating risk to the organization and its reputation, but due diligence can also aim to avoid harm to the environment and the public at large.

How exactly does a due diligence investigation prevent harm? By revealing potential risks that the investigating corporation can mitigate or avoid altogether. For example, a due diligence investigation may determine that a business targeted for acquisition poses risks such as:

·       frequent or unresolved litigation;

·       financial issues, including bankruptcy and tax discrepancies;

·       a history of illegal activity;

·       human rights violations; or

·       a connection to an individual or other company with a poor reputation.

A due diligence investigation can be warranted in a variety of situations, as we’ll explore next.

When is a due diligence investigation needed?

A due diligence investigation is necessary when a corporation is considering entering into a transaction that could have serious consequences. For example, a corporation should perform a due diligence investigation before it decides to:

·       merge with or acquire another company,

·       enter into a major agreement with a new business partner,

·       purchase real or intellectual property, or

·       hire someone to occupy an executive role within the business functions of the organization.

A corporation can use the results of a due diligence investigation to shape an informed decision-making strategy. After an investigation concludes, corporate leadership may decide to go through with the transaction as planned, implement mitigation measures, impose conditions on the subject of the investigation before committing, or walk away.

Because due diligence investigations tend to involve high-stakes matters, corporations must be careful about who they entrust with the process.

Who is involved in a due diligence investigation?

The key actors involved in a due diligence investigation are:

·       the investigators, who may be lawyers, financial experts, or professional investigators employed by the organization or retained through an external investigation firm;

·       officials within the investigating organization, who must outline the goals of the investigation and provide direction; and

·       representatives of the subject individual or company, who must preserve data and provide access to relevant information.

Performing due diligence investigations in house is certainly possible, but it can be challenging.

The most common challenges of due diligence investigations

A due diligence investigation can quickly get complicated and cumbersome, especially when it involves a company’s entire history. Some of the most common challenges of these type of investigations include:

·       Large volumes of data: Many companies store overwhelming amounts of data, from emails to financial records to legal contracts. As a result, the search and comprehensive analysis portion of an investigation can be incredibly time-consuming, and keeping track of important details can prove difficult.

·       Lack of resources: If corporations had unlimited amounts of time and money, due diligence investigations wouldn’t be that big of a deal; they could handle investigations in house without a second thought or outsource them to an expensive firm. But in reality, time and budgetary constraints can force corporate investigators to limit the scope of their investigations such that they overlook critical information and draw inaccurate conclusions.

·       Lack of expertise: Investigators may lack specialized knowledge about specific legal, financial, or other business issues. This can make it difficult for a general investigation team to analyze and interpret certain types of data sets.

Despite these challenges, the average due diligence investigation unfolds in predictable stages.

What is the difference between a due diligence investigation and a financial investigation?

Due diligence investigations and financial investigations are two distinct types of investigations conducted for different purposes. While due diligence investigations aim to assess the target company's overall viability, assets, (hidden) liabilities, risks, regulatory compliance, and other relevant factors to make informed decisions, financial investigations are narrower in scope and are specifically focused on financial matters, such as uncovering financial fraud, embezzlement, money laundering, or other illegal financial activities.

The 3 steps required to perform a due diligence investigation

When it comes to due diligence investigations, the devil is in the details, but the due diligence process itself is simple. The three steps of a thorough due diligence investigation are as follows.

1.     Prepare

Due diligence investigations are too large and complex to leave to chance. Therefore, every investigation should start with thorough preparation. First, outline the organization’s goals, priorities, and concerns in conducting the investigation. The more details the investigator has about potential risks, the easier it will be to guide the investigation in an appropriate direction.

2.     Investigate

As you might expect, the investigation step is the most involved stage of the process. During this step, investigators search, review, and analyze data to identify potential risks or discrepancies, taking detailed notes on their findings. Investigators may also need to conduct interviews or consult with experts to gather additional information about a particular issue.

3.     Report

To conclude the investigation, the investigator will write a report that summarizes the information sources they reviewed, the facts they found, and any potential risks they discovered. The report should conclude with recommendations as to how the organization should proceed.

Throughout this process, there are a few things to be aware of.

Best practices: A due diligence investigation checklist

When you’re evaluating the potential risks of a high-stakes decision, you must be relentless and dogged. Otherwise, you could miss important details and subject your organization to legal liability, financial loss, or reputational harm.

Here are a few key considerations and best practices to keep in mind when preparing for and conducting a due diligence investigation.

1. Maintain strong communication.

If the scope of your investigation is large, it may take a team of investigators to get the job done. Similarly, if your investigation involves complicated or unfamiliar subject matter, you should plan to call in additional resources. Identify suitable subject matter experts as soon as possible and notify them that you may need their input.

Give everyone involved an overview of the situation before your investigation begins and let them know the projected timeframe. Then, keep them apprised of any major developments so they can provide you with the best support possible.

2. Ensure adequate preservation.

You’re doomed to miss critical facts if the data sources you need to review have been lost, altered, or destroyed. Before you begin your investigation, verify that the subject of your investigation has taken steps to preserve relevant data and make sure you can access that data. If your corporation is investigating itself, you can take steps to preserve data for the investigation just as you would if you were issuing a legal hold.

3. Take a broad view of reviewable data.

A thorough investigation requires a review of all relevant data, wherever it may be found and whatever format it may be in. To identify and access that data, you must be prepared to search email and messaging applications, audio and video files, documents, spreadsheets, specialized applications, and more. Depending on the situation, relevant data may include:

·       legal documents,

·       financial statements and financial management software, 

·       employment systems and public records,

·       property records, and

·       compliance data and reports.

Given the rising amount of global business data, the only way to guarantee that you leave no stone unturned is to use proven technology to aid in your search. Let’s take a closer look at how technology can make in-house due diligence investigations more feasible.

End-to-end eDiscovery solutions streamline due diligence investigations

End-to-end eDiscovery software isn’t just for legal discovery; it can help corporations anytime they need to sift through and evaluate a large quantity of data. For an eDiscovery platform to enable more efficient due diligence workflows, it should be able to:

·       connect directly to the main applications the subject organization uses,

·       process large volumes of information,

·       quickly search documents for relevant content by file type and keywords,

·       facilitate collaboration between investigators and others, and

·       perform quality control checks to ensure that nothing has been missed.

Thanks to modern technology, you can find all these features and more in a single solution.