Meaning of Due Diligence

By | May 30, 2021

This term comes from American stock corporation law and can best be translated with “reasonable care”. The background to this is the liability of an auditor in connection with the valuation of a company or property in connection with the IPO or sale. The auditor subjects the company or property to a conscientious examination of its current condition and future profit expectations. The auditor is liable to the purchaser if the takeover ultimately turns out to be unprofitable. However, he can evade this liability if he can prove that the examination of the documents was carried out with due diligence which is short for DD by abbreviationfinder.

  • There are different reasons for due diligence: Buy Side Due Diligence, Vendors Due Diligence, the IPO and Outsourcing Due Diligence.
  • The weaknesses of due diligence include: the review process, the difference in knowledge between buyer and seller and remuneration.

Different occasions for due diligence

Depending on the initial situation for the examination, a differentiation is made between different due diligence approaches:

Buy side due diligence

In this case, the buyer selects the experts who should carry out the test for him. The test is based on different approaches. If the buyer wants to expand and plans to acquire a company, long-term strategic goals are pursued. In contrast, a financial investor sees the goal of a short to medium-term resale with the largest possible margin.

Vendors Due Diligence

In the case of vendors due diligence, the seller appoints the experts. In this case, it is important to determine the value of the company or part of the company and to uncover any weaknesses in advance of the sale, which must be eliminated before the sale with the aim of higher sales proceeds. If the object to be sold is to be offered to several buyers, it is also much more efficient to have just one expert report drawn up than for each interested party to send an expert himself.


Paragraph 3 of the Securities Act stipulates that an issue prospectus must be drawn up before an IPO, which provides investors with all the important information about the company. If investors suffer damage as a result of incorrect or incomplete information, the issuer, the companies accompanying the IPO and all persons involved are liable. The due diligence for an IPO is intended to ensure that all these risks of incomplete information are completely eliminated.

Outsourcing due diligence

This variant is mainly used in the IT industry. The subject of the audit here is on the one hand the machines to be outsourced, on the other hand the qualifications of the employees and the processes on which the execution of the tasks is based. This is usually about tenders. The service providers get an idea of ​​the infrastructure of the company placing the tender in order to be able to submit an offer based on it.

Due diligence weaknesses

Even if the procedure for such a test sounds sensible, it also has weak points. One of them is the review process itself, which is often carried out using standardized checklists. These checklists often do not take into account the individual and very special requirements of the client, but are kept too general in some points. Another weak point is the difference in the level of knowledge between the buyer and the seller with regard to very specific facts relating to the object at hand. It happens again and again that the information necessary for the purchase decision is not worked out transparently enough to achieve a level of information between the parties. The third critical point is the remuneration. Not permitted in Germany In other countries, a performance-related fee is definitely agreed. If there is no sale, the expert only receives a reduced fee. However, this results in a conflict of interest for those carrying out the due diligence, which can lead to information being processed in a way that promotes sales, but does not reflect reality or the requirements of the purchaser.