Due Diligence: Types and How to Perform

What is due diligence?

Due diligence is the process of researching and verifying information before making a decision or committing to a transaction. It aims to identify risks, confirm facts, and help parties make informed choices—commonly used in investing, mergers and acquisitions (M&A), hiring, and major purchases.

Key takeaways

• Due diligence reduces risk by uncovering material facts and potential problems.
• It combines quantitative (“hard”) analysis of financials with qualitative (“soft”) assessment of people, culture, and customers.
• Individual investors can perform effective due diligence using publicly available reports and disclosures.
• The same basic approach applies across contexts (stocks, startups, M&A), with adjustments for available data.

Brief history

The term gained prominence after the U.S. Securities Act of 1933, which required sellers and brokers to disclose material information. The law recognized a “due diligence” defense for sellers who had reasonably investigated and disclosed findings.

Types of due diligence

Context-specific:
* Commercial due diligence — market position, growth prospects, sales/R&D pipeline, supply chain, operations.
* Financial due diligence — audit of financial statements, cash flow, margins, accounting consistency.
* Legal due diligence — contracts, litigation, regulatory compliance, intellectual property, corporate formation.
* Tax due diligence — past exposures, liabilities, and tax optimization opportunities.

By approach:
* Hard due diligence — quantitative analysis of financial statements, ratios, cash flows, and legal documents. Focuses on measurable metrics (EBITDA, debt, receivables, capex).
* Soft due diligence — qualitative assessment of management quality, corporate culture, employee motivation, customer relationships, and brand strength. Often reveals integration risks in M&A or execution risk for startups.

How to perform due diligence for stocks (10 steps)

Most steps rely on company filings, investor presentations, and financial portals.

1. Analyze market capitalization — understand company size and typical volatility (mega/large-cap vs. mid/small-cap).
2. Review revenue, profit, and margin trends — track top-line and bottom-line performance, operating expenses, and return on equity over time.
3. Compare competitors and industry — benchmark margins, growth, and market position against peers.
4. Check valuation multiples — examine P/E, PEG, P/S, P/B and enterprise multiples; compare across peers and across time.
5. Assess management and insider ownership — evaluate experience, turnover, and whether executives hold meaningful equity.
6. Examine the balance sheet — assets, liabilities, cash levels, debt ratios, and any material year-over-year changes in footnotes.
7. Study stock price history and volatility — correlate price moves with fundamentals and consider suitability for your risk profile.
8. Consider dilution risk — outstanding shares, potential future issuance, and equity-based compensation.
9. Review expectations — consensus analyst forecasts, guidance, and material company updates (partnerships, IP, product launches).
10. Identify long- and short-term risks — regulatory, legal, market, competitive, and macroeconomic scenarios; stress-test assumptions.

Due diligence tips for startup investments

• Expect limited historical financials; focus on the business plan, unit economics, and market opportunity.
• Require a clear exit/harvest strategy (IPO, acquisition, secondary sale).
• Consider co-investing or partnerships to spread risk.
• Prioritize startups with scalable products, realistic growth plans, and strong founding teams.
• Assess runway, capital needs, and contingencies for changing market/technology conditions.

M&A due diligence

M&A due diligence blends hard and soft analyses to evaluate value, synergies, and integration risk.

Hard due diligence (typical activities):
* Audit financial statements and projections (EBITDA, cash flow, capex).
* Review receivables/payables aging and working capital.
* Analyze contracts, liabilities, ongoing litigation, and regulatory exposure.
* Assess tax positions and potential liabilities.
* Evaluate intellectual property, physical assets, and third‑party supplier relationships.
* Identify operating redundancies or cost-saving opportunities.

Soft due diligence (people and market fit):
* Assess cultural compatibility, leadership strength, and employee retention risks.
* Review compensation and incentive plans to align post‑deal behavior.
* Gauge customer satisfaction, supplier relationships, and brand reaction to ownership change.
* Use interviews, site visits, and customer/supplier feedback to surface integration risks.

Common due diligence checklist items

• Corporate structure and ownership
• Financial statements, audits, and forecasts
• Material contracts and leases
• Debt, contingent liabilities, and legal exposures
• Intellectual property and licenses
• Tax filings and exposures
• Employee agreements, benefits, and key personnel
• Customers, suppliers, and market position
• Regulatory and compliance records
• Insurance coverage

Frequently asked questions

What is the purpose of due diligence?
* To minimize surprise exposure by collecting and verifying material information before committing to a transaction.

What is a due diligence checklist?
* A structured list of documents and topics to review—financials, legal, tax, contracts, HR, operations, customers, and risks.

What are examples of due diligence?
* A buyer inspecting a property’s condition before purchase, an acquirer auditing a target firm before closing, or an employer running background checks on a candidate.

The bottom line

Due diligence is a disciplined process of fact‑finding and risk assessment. Combining rigorous financial review with qualitative evaluation of people, culture, and market dynamics yields the most reliable basis for decisions—whether investing in a stock, funding a startup, or completing an acquisition.