Investigations for Companies: Due Diligence

In the context of corporate acquisitions, mergers, or high-profile investments, the investigative agency Argo conducts due diligence investigations to enable clients to assess the reliability of the counterparty and to identify any risks associated with the transaction in advance.

The English term due diligence (literally meaning “due care”) refers to the investigative activity aimed at collecting and verifying data and information related to the subject of a negotiation. The purpose of this activity, carried out by the investigative agency, is to evaluate the convenience of a deal and to identify the risks and issues connected to negotiating the terms and contractual conditions, as well as preparing adequate instruments of guarantee, indemnity, or compensation.

The goal of due diligence is to determine whether there are any critical issues that might compromise the successful outcome of a negotiation. It is therefore an investigative activity aimed at understanding the convenience of the planned deal, the most suitable structure of the operation, the elements useful for defining the price, guarantees, and contractual conditions to be included.

Generally, the primary purpose of a due diligence investigative inquiry is to ascertain, through targeted and analytical information gathering, whether the actual conditions for the feasibility of the planned operation exist or if there are critical elements and risk factors that could jeopardize its success, while simultaneously building a solid foundation for the possible negotiation of the operation’s contractual terms.

Failing to conduct due diligence may lead to contractual liability on the part of the party obligated to perform it. Article 1176 of the Italian Civil Code requires that, when fulfilling an obligation, the debtor must exercise the diligence of a prudent family man.

Due diligence investigations are primarily conducted in connection with projects involving the acquisition or transfer of company shares, mergers or demergers, sales and leases of businesses, issuance of financial instruments (such as share or bond placements), and in anticipation of the purchase of shares in closed-end mutual funds by asset management companies (known as S.g.r.). They are also used in many other transactions, for example when deciding on a company’s stock market listing, a capital increase, or the stipulation of a joint venture agreement. Finally, it should be noted that due diligence may concern the entire business or only part of it (e.g., a business unit or sector).

In all these cases, due diligence investigations involve the collection and verification of information concerning the subject of the negotiation in order to form a judgment on their market value and potential yield. This process is conducted by a third party, independent from both the offeror and the interested buyers.

The term due diligence thus refers to the investigation and fact-finding activity concerning a specific target, which may be a company, a group of companies, a particular investment, or other entities.

The objective of investigative due diligence is to minimize the risks associated with the transaction by identifying any potential risk areas of the target company and gathering all necessary information to evaluate the company’s business affairs in order to detect any risks or issues with the investment.

Due diligence investigations are usually carried out after signing a letter of intent and before the preliminary contract, or sometimes after the preliminary contract, in which case they serve to determine any necessary price adjustments (price adjustment):

• Pre-acquisition due diligence: the investigative activity conducted before the closing of the transaction, aimed at validating (or not) the prospective buyer’s intention to proceed with the acquisition, the operational methods, and the most efficient legal instruments, as well as contributing to defining fundamental aspects such as the actual economic, financial, and asset situation of the target, organizational efficiency, and quality of human resources, “preparing the ground” for the subsequent negotiation of price, contractual guarantees, and indemnities for the buyer.
• Post-acquisition due diligence: less common and usually limited to accounting aspects. Any discrepancies found may allow the buyer, based on the acquisition agreement, to activate procedures for price adjustments or, in more serious cases, to refrain from entering into the final contract or to request its termination.

The most common types of due diligence, sometimes integrated with each other, are as follows:

• a) Business Due Diligence: This activity, carried out by the investigative agency, involves analyzing the organizational and economic-financial structure, market position, characteristics, and potential of the company (e.g., evaluating the investment plan and the company’s future market prospects).
• b) Accounting and Tax Due Diligence: This investigative activity involves analyzing the company’s accounting and tax situation through examination of financial statements and income statements, verifying their compliance with civil and tax laws and correct accounting principles, checking the regularity of accounting and VAT books, income tax returns, and any tax audits carried out by authorities. It also includes assessing the effectiveness of internal controls and operational risk areas, and verifying transactions and internal documentation. Essentially, this due diligence analyzes the company’s financial statements to verify their accuracy and compliance with tax regulations. This investigative activity allows assessing the financial “health” of the target company, identifying risk areas to prevent and detect potential fraud, financial crimes, or possible sanction-related problems. Due diligence can therefore also be considered a tool to evaluate the solidity of a company, its corporate assets, and its overall “health,” not only in terms of economic, financial, and asset solidity but also regarding compliance with applicable laws by those who have managed the company since its inception.
• c) Legal Due Diligence: This investigative activity involves analyzing obligations assumed by and toward the company and their fulfillment, verifying the presence of contractual clauses that may negatively affect negotiations, analyzing labor relations with employees and collaborators of the target company, and checking the proper fulfillment of all company obligations, especially concerning occupational safety and accident prevention measures. It also includes examining relationships with banks and other financiers in terms of contracts in force and guarantees issued by or in favor of third parties and shareholders, as well as rights concerning intellectual and industrial property.