Due diligence facts for kids

Due diligence is like doing your homework very carefully before you make a big decision or agree to something important. It means taking the time to investigate and gather all the facts you need to know. Imagine you're buying a used bike; you'd check the brakes, tires, and gears, right? That's a simple form of due diligence!

In the business world, it's a super important process. For example, if one company wants to buy another, they'll do a lot of due diligence. This helps them understand everything about the company they want to buy, like its money, legal situation, and how it's run. The main idea is that by doing this careful check, people can make smart, informed choices, knowing all the good and bad points, and understanding any risks involved.

What Does "Due Diligence" Mean?

The words "due diligence" basically mean "required carefulness" or "reasonable care." People have used this idea of needing to be careful since the 1400s! It became a special legal and business term because of a law in the United States called the Securities Act of 1933. This law said that companies selling investments had to do a "reasonable investigation" to make sure they told investors all the important information.

If these companies did their "due diligence" (their required carefulness) in checking out a business and shared what they found, they wouldn't be blamed if some information they didn't find later came out. Because of this, checking things carefully became a normal practice for companies selling investments. Over time, the term "due diligence" started to be used for the whole process of investigating, not just how carefully it was done.

When Do People Use Due Diligence?

Due diligence is used in many different situations, especially when big decisions are being made.

Buying or Merging Companies

One of the most common times due diligence happens is when a company wants to buy another company, or when two companies want to join together (this is called a merger). The buyer will carefully check out the company they want to acquire. This helps them answer important questions like:

• How should we buy this company?
• How should we set up the deal?
• How much should we pay for it?

This investigation looks at many different parts of the company, such as:

• Money stuff: Checking financial records to see if the company is making money and is healthy.
• Legal stuff: Making sure there are no hidden lawsuits or legal problems.
• How it's run: Looking at the management team and how the business operates.
• Technology: Checking their computer systems and data security.
• Market: Understanding their customers and how they fit into the market.

All these checks help the buyer decide if the deal is a good idea and how much the company is really worth. It helps reduce the chances of a bad deal.

Preventing Problems Overseas

Some countries have laws, like the Foreign Corrupt Practices Act (FCPA) in the United States, that aim to stop bribery when doing business in other countries. To follow these laws, companies need to do due diligence on their partners, suppliers, and even companies they might buy overseas.

This involves two main steps:

• First check: Before starting a relationship, they investigate to see if there's any risk of corruption.
• Ongoing checks: They keep checking regularly to make sure their overseas partners aren't linked to any illegal activities.

This helps companies avoid getting into trouble by accidentally being involved in bribery or other bad practices.

Protecting Human Rights

More and more, companies are expected to do due diligence to make sure their business activities don't harm human rights. This means they need to investigate their own operations and their partners to prevent problems like unfair labor practices or unsafe working conditions.

Organizations like the OECD (a group of countries working together) and the United Nations have created guidelines for businesses. These guidelines encourage companies to:

• Understand how their business might affect human rights.
• Keep an eye on these effects.
• Work to prevent or reduce any negative impacts, even if the problem comes from a business partner.

This helps make sure companies act responsibly around the world.

In Legal Cases

Due diligence is also important in legal cases. For example, if someone needs to find another person for a lawsuit, they must make a reasonable effort to locate them. In other words, they must show they did their "due diligence" to find that person.

Also, if you're asking a court for something, you often need to show that you've done your homework and have a good reason for your request. It's all about making sure people act responsibly and investigate properly before taking legal steps.

Due Diligence as a Defense

Sometimes, if a business is accused of breaking a rule or regulation, they can use "proper use of a due diligence system" as a defense. This means they can show that they had a good system in place to check things carefully and that they followed it. For example, in the United Kingdom, if a business sells timber, they might be able to defend themselves against a charge if they can prove they did proper checks on their timber suppliers.

See also

• Data room
• Duty of care
• Integrity management
• Non-disclosure agreement
• Standard of care
• Vetting