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Organisation of the due diligence process – part 1

Krzysztof WOŹNIAK
Audit Senior at RSM Poland

What is due diligence?

The condition for making right investment decisions is possessing reliable and accurate information. In sale and purchase transactions there is a significant asymmetry of information, and the seller always has a significant information advantage over the buyer. In order to minimize the risk related to their potential purchase, investors have developed a series of measures to protect their interests. Due diligence is one of the tools that should be used before making the final investment decision. It should be noted that the higher the investment risk, the more attention should be paid to it.

Due diligence is a process involving the audit of the potential investment aimed at providing information due to which the parties interested in the purchase and sale transaction will make the most appropriate decision. The term due diligence is explained in literature as examination with due diligence and reliability. The examination should be understood here as all the procedures and analyses intended to identify the most important opportunities and risks from the buyer’s point of view. The due diligence process itself is also referred to as a pre-investment audit. It should be noted that the procedures, the progress and the report on the due diligence results are not limited by any legal act; therefore, any arrangements concerning the process should be agreed upon by the buyer, the seller and experts who will be conducting the agreed procedures.

Such technically highly advanced examinations should be always conducted by a specialised and experienced group of experts who will be implementing agreed procedures while observing the "due diligence" as specified in the definition.

Due diligence may be conducted at the request of both the buyer and the seller. For obvious reasons, the buyer wants to obtain as much information about its potential investment as possible, and to minimise its risk. If due diligence is ordered by the seller, the seller usually wants to prepare the best for the negotiation process by the identification of as many risks and threats as possible, but also by the identification of the opportunities and strengths of its company. When the information is confirmed by experts, it is possible that the seller will be able to negotiate a higher transaction price. Furthermore, very frequently due diligence ordered by the seller is connected with conducting additional procedures by external specialists consisting in the valuation of the company that is the subject of the transaction. Such a valuation, along with the identification of strengths of the transaction subject, protects in such case the interest of the seller and helps the seller to conclude a transaction under more favourable conditions.

Nowadays, due diligence service is treated as an international standard, known and used in a majority of countries around the world, depending on the economic conditions prevailing there. Due to the fact that originally due diligence was used for the purposes of mergers and acquisitions of enterprises or their parts, this examination is still associated precisely with these types of transactions. The procedures of this examination are unnamed procedures; the scope of the analysis is virtually unlimited and depends largely on the needs of the parties to the transaction and the conditions of the environment in which the transaction will take place.

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