Due diligence

Due diligence is an investigation of a business or person prior to signing a contract, or an act with a certain standard of care.

It can be a legal obligation, but the term will more commonly apply to voluntary investigations. A common example of due diligence in various industries is the process through which a potential acquirer evaluates a target company or its assets for an acquisition. The theory behind due diligence holds that performing this type of investigation contributes significantly to informed decision making by enhancing the amount and quality of information available to decision makers and by ensuring that this information is systematically used to deliberate in a reflexive manner on the decision at hand and all its costs, benefits, and risks.

The term “due diligence” means "required carefulness" or "reasonable care" in general usage and became a specialized legal term and later a common business term due to the United States’ Securities Act of 1933, where the process is called "reasonable investigation" (section 11b3). This Act included a defense at Section 11, referred to later in legal usage as the “due diligence” defense, which could be used by broker-dealers when accused of inadequate disclosure to investors of material information with respect to the purchase of securities. In legal and business use, the term was soon used for the process itself instead of how it was to be performed, so that the original expressions such as "exercise due diligence in investigating" and "investigation carried out with due diligence" were soon shortened to "due diligence investigation" and finally "due diligence".

As long as broker-dealers exercised “due diligence” (required carefulness) in their investigation into the company whose they were selling and as long as they disclosed to the investor what they found, they would not be held liable for non-disclosure of information that was not discovered in the process of that investigation.

The broker-dealer community quickly institutionalized, as a standard practice, the conducting of due diligence investigations of any stock offerings in which they involved themselves. Originally the term was limited to public offerings of equity investments, but over time it has come to be associated with investigations of private mergers and acquisitions as well.

Due diligence takes different forms depending on its purpose:

The due diligence process (framework) can be divided into nine distinct areas:

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