What is due diligence? How can software development company handle this process?

Nobody likes to buy a pig in a poke, especially if we want to invest in some enterprise and ensure that the investment will bring benefits as opposed to troubles.  

At first glance, the onset of inflation, rising interest rates, and an enduring global pandemic should cause a slow down in international mergers and acquisitions. Nevertheless, the first half of 2022 was successful for deal makers.  

According to statistics by PWC, this amounted to more than 60,000 publicity disclosed deals breaking US$5tn in value for the first time.1 In the year's second half, already existing obstacles and the Russia-Ukraine conflict toned enthusiasm down. Still, the PWC analysis found better returns for buyers during the downturn and shows how deals launched during such times can achieve outsized growth.  

Due diligence supports investors and companies in understanding the nature of the deal, the risks involved, and how the transaction fits a portfolio. It also helps identify potential issues and liabilities related to kind of operations.

What is due diligence?

Due Diligence is a process that involves risk and compliance checks, conducting investigation, review, or audit to verify facts and information about a particular subject. It is basically used in industries such as real estate, finance and companies considering M&A. Investors who desire to acquire shares or stocks, a merger of companies, or when planning to go public are also interested in the due diligence process.

This process can include evaluating a company's environmental impact, labour practices and governance structure, among other factors. It helps investors to identify and manage potential risks and opportunities associated with the company's business practices.

This process is usually conducted by equity research firms, fund managers, individual investors, risk and compliance analysts and firms and broker-dealers. However, individual investors can go through on their own. Due to how complicated the due diligence process may seem, in recent years, services have appeared on the market, which, thanks to their solution, make it faster and easier to conduct investment audits.  

Nowadays, more and more investors are concerned about the sustainability of their investments and portfolios. ESG due diligence is the response of this new trend. It consists of evaluating a company's performance on environmental, social, and governance issues to assess its potential impact on financial returns. It is a way for investors to do long-term sustainability and ethical practices of a company before investing. It helps to manage risks, identify opportunities, and align investments with personal values, leading to better long-term returns and a more sustainable economy.

What are the types of due diligence?

  • Financial due diligence – ensures financial statements are accurate and sustainable.  
  • Legal due diligence - includes licenses, regulatory issues, contracts, and legal liabilities.
  • Operational due diligence – focus on how the company turns inputs into outputs.  
  • Tax due diligence – ensures that the company pays current tax liabilities.  

When should due diligence be conducted?

The most common case of due diligence is mergers and acquisition, but there are other situations in which due diligence is advised:  

  • Establishing new business relationships: due diligence is used to gather information and perform a risk assessment. It ensures that the customer is not using a fake or forged identity to access their services.  
  • Money laundering suspicion: if you have any doubt regarding whether your customer is  involved in money laundering or terrorist financing, you should consider due diligence.  
  • Unreliable documentation: this process checks if there are transactions, including amounts of money that exceed regulatory thresholds and with entities in high-risk foreign countries.

Why is due diligence essential?

An attractive offer from a prospective buyer is always a tasty morsel for business owners. Mergers and acquisitions can be an opportunity to develop business and profit from the new investment.  

This complex process contains long-term analysis and data collection, providing two enterprises with valuable market share, expanded equality, and increased profits under ideal conditions.  

Simultaneously, when this process is done, it can lead to cultural clashes, litigation, and a massive loss in profits.

Due diligence’s two perspective

Thanks to due diligence there are higher chances of success and  investors can make more conscious decisions. There are two perspectives which should be considered.  

Buyer’s perspective  

In mergers and acquisitions (M&A), purchasing a business without due diligence significantly increases the risk to the purchaser, so the buyer can feel more comfortable and assured about the transactions after due diligence.

Seller’s perspective

There are also benefits for sellers. They can go through a financial examination which may verify that the market value is higher than expected. So, it is quite common to get through the due diligence process by sellers.

How does IT support the due diligence process?

IT due diligence, also known as technology due diligence, entails an examination of an organization's IT systems and procedures (frequently with a focus on security assessment). Acquirers need to be aware of assessing all areas of risk including technology, and this remains an ongoing and pressing need.

The most important result of technical due diligence is the identification of business and technical risks. The processes performed and resulting processes describe the costs, investments, and opportunities associated with the transaction. It also provides information on the growth and scalability of private equity firms.

Technology really helps in due diligence because an analyst has to go through lots of data, so IT can help to collect, organize, and analyze large amounts of data related to the target company's technology. What is more, it can help to communicate and collaborate between the due diligence team and the target company. This can include setting up secure channels for sharing data and documents, as well as providing tools for virtual meetings and remote collaboration.  

IT due diligence can include financial data, technical data, and data on the company's IT processes and infrastructure. The purchasing company can assess current IT structures and spot any potential security issues thanks to this part of M&A due diligence. Therefore, this could involve reviewing:

  • Technology debt
  • Software licensing  
  • Open Source Substances
  • Technical dangers
  • Security evaluation
  • How sensitive information is handled and safeguarded

The identification of business and technology risk is the result of technical due diligence. The deliverable and subsequent procedure provide an overview of the transaction's expenses, investments, and prospects. It also offers data on the private equity firm's expansion and scalability.

Decentralized due diligence

A very interesting example of an IT solution that simplifies and automates the due diligence process is the decentralized platform of Umazi, a London-based startup cooperating with FINGO. Umazi creates digital identities for businesses, which are then verified and validated. These digital identities, containing Due Diligence data, are stored on an open blockchain platform. As a result, the entire audit process becomes more transparent and can be conducted in real-time, enabling financial institutions to better manage their clients' data. This way, doubts can be resolved promptly or a list of questions can be generated for potential borrowers, saving both parties time and nerves. Umazi's functionality stems from a thorough analysis of the Due Diligence processes and the accompanying challenges.

Due to the blockchain technology customers have the flexibility to securely share data with external entities beyond the Umazi ecosystem while maintaining a high level of trust. Moreover, if they desire, customers have the option to personally hold and store their identity wallet on their own infrastructure instead of relying on Umazi. The company gives the customers access and control of their profile. Their platform stores (for them) a form of verifiable credentials - cryptographically signed pieces of structured data based on open W3C standards. These credentials are attached to decentralised identifiers (DIDs) which enable the data subject to prove control of them using their own cryptographic keys. Specialised blockchain networks such as Cheqd, Sovrin, ION and Dock have emerged to enable the distributed storage of these DIDs, acting as a kind of cryptographic phonebook which isn't under the control of any one vendor (including Umazi!)

According to Cindy van Nikerk, CEO of Umazi, Difficulties establishing trusted relationships hold businesses and individuals back from achieving their full potential. If we could harness the energy we put into proving who we are and that we are legitimate into more constructive pursuits, just think how much happier and more productive we would all be!  

Therefore, decentralized Umazi solutions make the entire audit process  more transparent and can be conducted in real-time, enabling financial institutions to better manage their clients' data. This way, doubts can be resolved promptly or a list of questions can be generated for potential borrowers, saving both parties a lot of time and hassle.

Final thoughts on due diligence

We must acknowledge the transforming potential of due diligence in our decision-making. It's more than just a checkbox to tick off. It's a way of thinking that enables us to make wise decisions and live a confident life. Nevertheless, the benefits it provides in the form of well-informed choices, reduced risks, and increased chances make it an essential habit in both our personal and professional lives.

1 https://www.pwc.com/gx/en/services/deals/trends.html

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