Due Diligence Process | What It Is, Why It Matters, and How to Get It Right

The concept of due diligence had legal roots. In the U.S., it became a formal practice with the Securities Act of 1933, requiring brokers to disclose material information completely about securities being sold. 

Therefore, the law provided a “due diligence” defense. According to the check, if the brokers conducted the investigation and disclosed the result, they could avoid liability for any undiscovered information.

Over time, the term expanded beyond finances and law into general business usage. Today, due diligence is a critical part of compliance and risk management across diverse industries. From evaluating the vendors and third parties to complying with AML regulations, due diligence helps to understand the business and its related risks.

What is Due Diligence?

Due Diligence definition refers to scrutinizing and verifying information regarding a business partner, investor, or legal entity. The process is carried out before entering into a formal collaboration.

In practice, it means the business exercises reasonable attention and thoroughness to “vet” all important facts, rather than taking things at face value. By being proactive instead of reactive, companies aim to identify any hidden risk in advance. 

Essentially, due diligence is about “digging into the details”, whether examining a merger target’s finances or checking an entity’s background, to ensure informed, risk-aware decision-making.

What are the Primary Types of Due Diligence?

Due diligence – an umbrella term is applied to multiple contexts, depending on the situations and the target of the review. In the context of Know Your Business, companies encounter several types of due diligence, each with a slightly different focus. 

Here are some of the most common types of due diligence outlined:

• Customer Due Diligence
• Vendor Due Diligence
• Third-Party Due Diligence
• Regulatory Due Diligence
• Enhanced Due Diligence
• M&A Due Diligence 
• Commercial Due Diligence 

What is an Example of Due Diligence?

One of the most common examples of due diligence in business is when a bank verifies the identity and legitimacy of any new client before opening a business account. 

Suppose A mid-size bank is approached by a foreign company, “GlobalTrade Ltd.”, which is looking forward to opening a bank account. In order to approve the request, the bank is required to conduct due diligence as part of Know Your Business and AML obligations.

The due diligence will include business verification, ownership & control checks, sanction & PEP screening, and proper risk assessment to make the final decision. It will help the bank to comply with AML regulations and avoid inadvertently doing business with a shell company.

How to do Due Diligence?

Conducting due diligence is a structured procedure involving several stages, from collecting information to ongoing monitoring. A proper and accurate process assists in ensuring no critical aspect is overlooked when assessing a business. 

Why is Due Diligence Important?

With the fast-moving world, simply taking a business at its word is not enough. Conducting due diligence is essential because it ensures that a company will be able to know who it is doing business with, both legally and ethically. 

It is important to verify business entities through due diligence procedures to protect organizations from fraud, financial crimes, regulatory penalties, and reputational damage. The following are the reasons why the due diligence procedure is crucial:

• Confirms the legitimacy of the business.
• Identifies Ultimate Beneficial Owners(UBOs)
• Detect red flags and risk indicators 
• Ensure regulatory compliance
• Protect reputation and brand’s integrity
• Encourage strategic decision-making

Who Conducts Due Diligence Checks?

The due diligence checks vary across different legal entities depending on the nature of transactions and the relationship.

In the competitive market, these checks are often led by equity research firms, fund managers, compliance teams, and risk analysts. Each of them assesses potential risk and opportunities before making the investment or collaboration deals.

Moreover, due diligence is a shared responsibility across different roles and sectors, which is customized according to the nature of the business and the risk level of each transaction.

What Does a Due Diligence Check Look for?

All existing and potential business partners, along with their subcontractors, are adequately assessed. The due diligence report includes all the following factors:

1. Red flags
2. Negative reports in the international press
3. Adverse media reference 
4. Sanction list in accordance with the entity
5. PEP(Politically Exposed Persons) list  
6. Assets and liabilities
7. Company’s history 
8. Board members, UBOs, shareholders, and beneficiaries
9. Organizational activities.
10. Financial statements.

What are the Challenges of the Due Diligence Process?

Integrating a strong due diligence approach in business verification has its share of challenges. It is essential to stay aware of these challenges as it is the first step; the next is opting for the best practices to overcome them. Some of the common hurdles an organization faces in due diligence are highlighted below:

• Data collection and verification difficulties. 
• Regulatory complexities and variability. 
• Resource constraints.
• Operational delays. 
• Security and data privacy risk.
• Limited access to public records. 
• False sense of security from the checklist.
• Maintaining the audit trails and documentations.

However, organizations are managing to mitigate the challenges effectively through the adoption of best practices. Additionally, the need to thoroughly investigate and assess risk has become crucial. Therefore, the challenges discussed above can be turned into strengths with the right approach.

What is the Role of  Due Diligence in KYB (Know Your Business)?

Due diligence in Know Your Business (KYB) is a critical function that underlines trust and compliance in the fast-growing world of business. By thoroughly investigating and understanding the businesses they deal with, companies protect themselves from illicit activities, regulatory penalties, and reputational harm. 

Moreover, automated KYB strategies enable companies to speed up the onboarding process significantly, while enhancing compliance checks. It helps in catching issues that manual processes might miss. Therefore, the due diligence checklist in KYB is not just about combating financial crimes, but also ensuring partners meet ethical standards. 

How Can You Build a Strong Due Diligence Program with The KYB Solutions?

We live in a world where the regulatory landscape is evolving, and the need for robust due diligence services isn’t optional but a necessity. The KYB platform assists your business with automated verification tools, risk assessment, and comprehensive KYB checks. You can navigate complicated requirements and prevent illegal activities. 

The KYB’s due diligence solutions streamline risk management while protecting your company’s reputation. With access to reliable and accurate global data points, its dashboard brings clarity and speed to your compliance process. 

Whether you are onboarding partners, verifying suppliers, or ensuring sustainability compliance under the EU’s Corporate Sustainability Due Diligence Directive, The KYB makes it simple and seamless. Contact us today and request a demo.