Due diligence is an investigation of a business or person prior to signing a contract, or an act with a certain standard of care.
Due diligence refers to a legal obligation to fully audit or examine a potential investment option. More specifically, the legal term refers to taking all possible actions to ensure that the material facts are correct.
The term due diligence is usually applied to voluntary investigations despite its legal nature. It came into the financial lexicon after introduction of Securities Act of 1933 that included the term 'Due Diligence' in Section 11.
The term was applicable to brokers or dealers that traded in securities in the stock exchange. As long as they exercised 'due diligence' when evaluating the equity of the company they were selling, and disclosed their findings to the public, they would not be liable for non disclosure of information that was not evident during the investigation.
Due diligence simply refers that an individual should take reasonable care before entering into a transaction or agreement with another person. The action includes reviewing the financial records as well as any information that will weigh heavily on the purchase decision.
The due diligence process involves reading the fine prints and evaluating associated documents including equity vesting plans, financial reports, ownership document, corporate officers. Every investor is legally required to ensure due diligence before entering into any transaction to avoid the prospect of losses.
Due diligence is not only performed by a buyer, but the seller as well. The seller may perform due diligence to ensure that the buyer has the ability to pay for the purchase. This action is taken to prevent harm to any of the party involved in the investigation. Performing due diligence increases the chance of making informed decision as all the factors including costs, risks, and benefits are evaluated before entering into a transaction.
The main goal of the activity is to ensure that there are no hidden traps or drawbacks apropos a particular transaction. It helps a company to avoid being a victim of fraud. Apart from that, during the due diligence process a company will be able to gain better understanding about the deal that will result in making the right business decisions.
Financial education is so important, but barely taught at all in our schools. Having resources online is great, but not if they are inaccessible to so many. Thanks 508!