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A due diligence report is a comprehensive, objective, and factual report into the current state of a company, organization, or property.
The document is the principal output of the due diligence process, which is an investigation or analysis of these same entities. The content, structure, and audience of the due diligence report can vary depending on the industry or the context of the entity undergoing due diligence.
In this article, FirmRoom looks at the importance of this document, how it is constructed, and why no good due diligence process is complete without one.
Good business outcomes are based on informed decision making.
In general terms,assuming rational actors, the more informed the decision making, the better the outcomes. The role of due diligence, and by extension the due diligence report, is to lead decision makers to a situation where they have the information they need to generate value for themselves, their company, or their organization.
The due diligence report can be impactful in a wide range of situations.
Whatever the investment (a company, piece of machinery, property, etc), a due diligence report can highlight what the investor should know in order to decide i) whether an investment should be made, and ii) a suitable offer price.
Even for those who aren’t looking for an immediate transaction, such as company owners, can benefit from a due diligence report. Think of all those corporate scandals that might have been stopped in their tracks by company shareholders with a thorough due diligence report.
Large projects require significant due diligence to prove their sustainability. For a large infrastructure project, in addition to financials, this can include environmental impact reports, community feedback sessions, and cost benefit analyses, all of which would find their way to the due diligence report.
Whenever a company or organization is about to jump into a new partnership, it should only do so after becoming fully informed of the counterparty. This is true whether it’s suppliers, contractors, or JV partners. Good characters tend to produce better results, so it pays to ensure that the other side is a good character.
Taking these three contexts, we can apply them to any number of companies, organizations, markets, and industries.
For argument’s sake, let’s look at the case of a hypothetical big box food retailer.
A due diligence report for such a company could include:
Without a due diligence report, a company risks making decisions without any or all of this information.
The consequences of this can sometimes be disastrous. Looking at real-life examples of retailers who failed to conduct adequate due diligence in different circumstances, we see that failure to generate a due diligence report can ultimately lead to billions of dollars in value destruction.
These are just some of the high-profile cases. And the ones that come to light. With several tiers in a typical supply chain, retailers are constantly exposed to numerous risks that place their business in jeopardy.
Ongoing due diligence, with a comprehensive due diligence report communicating findings (and minimizing legal risks) is invaluable in companies like these.
Due diligence reports on acquisitions tend to cover every part of a target company’s operations and its environment.
Most due diligence reports, however, whether conducted internally or by third parties, will tend to focus on certain aspects of the business.
In the case of the food retailer, due diligence into supply chain partners would usually amount to a single due diligence report.
Essentially, there are as many forms of due diligence reports as there are due diligence.
When examined in isolation, it could mean that a company or organization is particularly concerned with certain findings of a broader due diligence and is deciding to double down on it, or because one part of the usual due diligence framework is considered so important that it merits its own report.
Examples here include:
The most likely due diligence report to be produced in isolation. The financial due diligence report will often involve forensic accounting teams, who investigate the accounting practices, controls, and results of firms.
The recent accounting scandal exposed at Brazilian retailer Americanas, which used zero based budgeting (ZBB), arose because of an internally conducted financial due diligence report.
There’s a good chance that legal due diligence reports are conducted on individuals as much as companies. These due diligence reports are sometimes called ‘background checks’ and can involve everything from checking the criminal records of an individual to legal proceedings involving members of a company’s board of directors.
Acquisitions involving IT firms will almost certainly include an independent technical due diligence report because of the importance of these companies’ technical aspects to their overall value. These reports look at everything technology-related, from a company’s technology stack to its IT support.
Companies that achieve ‘unicorn’ status often do so through holding patents. Uber, for example, has nearly 300 patents registered under its name. For anybody seriously interested in understanding Uber’s future prospects, that’s a lot of due diligence and inevitably, it leads to an IP due diligence report.
This is essentially a detailed report into a company’s vendors and its supply chain. This form of due diligence report has become increasingly popular over the past two decades, as companies seek to ensure that their supply chains are sustainable (i.e., fair wages, sustainable production practices, etc.).
Ultimately, the biggest driver of whether a due diligence report should be internal or external is what it’s looking to achieve.
If there’s an attempt to expose some dodgy dealing by company management, it makes little sense to ask them to conduct internal due diligence.
On the other hand, if the goal is to find the reason for company underperformance, it may be better to conduct internally, hitting up those with intimate knowledge of the company for their insights.
Let’s look at a general due diligence report, considering a large sized company for a joint venture with another company.
DealRoom has already provided a template for a due diligence report, which can be seen here.
The sections required in a typical report, include:
Where the most important issues uncovered (or, perhaps even more importantly - issues which remain uncovered), by the due diligence process are highlighted for the reader.
Whereby the document outlines the express aims of the due diligence process. It’s possible that by reading this, the reader might suggest alternative approaches to future stages of the due diligence.
Whereby due diligence is conducted across the financial/legal/operational/HR/technical components, and the findings for each are clearly summarized. Each section may include its own executive summary in order to highlight the most important aspects of that function in the company.
Based on the findings of the due diligence report, the authors may decide to include next steps. This could be further due diligence, following up on some areas, or even calling off the investment/M&A/partnership, etc.
Consider the following broad pieces of advice, when writing a due diligence report:
A limited number of authors should work on the document. This tends to reduce delays by focusing responsibility. These should be involved in the due diligence process from the outset, enabling them to take notes for the report as the process progresses.
If it cannot be written in 20 pages, it cannot be written in 200 pages. The aim of the due diligence report is to provide an informed conclusion, not to write a document for a document’s sake. Whoever is reading the document is likely to be time constrained. They will thank you for coming to the point.
Related to the previous point is the need to be specific. When putting the document together, always ask ‘what is the point of this section?’ and this should be followed up by ‘what do I need to say to get this across as quickly as possible?’ Flowery language has no place in these documents.
The due diligence process itself will tend to influence the headings in a due diligence report. That is, certain issues raised in due diligence, by their nature, will merit their own headings. That said, a due diligence report template is an excellent idea, providing a roadmap even for experienced report authors.
FirmRoom regularly works with companies and organizations putting together due diligence reports.
This is a natural extension of our due diligence software, and the two have been developed to complement each other. These reports can be tailored to an individual context (company size, industry, issue).
A due diligence report is only as good as the due diligence that underpins it.
This requires technology and a due diligence project management platform like FirmRoom.
Our solution has evolved over the past decade to become the choice of those conducting the most rigorous due diligence processes, be those billion dollar acquisitions, large legal cases, or simply conglomerates conducting a deep dive into their operations.
Our solution focuses on security, organization, and collaboration - three components that all the best due diligence processes have in common.
A due diligence report can be conducted by everyone from individuals to large organizations, and for a wide number of purposes.
A well put together due diligence report enables the reader to become informed, thus making better decisions. The document should communicate what decision makers need to know, giving the document an important role in a company’s management decision making process.
A due diligence report is a comprehensive document that communicates the findings of a due diligence process, highlighting the most important issues uncovered by the process.
A trusted individual, internal or external to the company, with the ability to interpret and communicate large amounts of information should be entrusted with the due diligence report.