Why is due diligence necessary in business acquisitions?

Due diligence is the inspection and evaluation process by which parties in an acquisition or merger will determine whether the proposed deal is acceptable.

For the buyer, due diligence is key to arriving at a valuation of the business and confirming that the deal is worth doing.

Due diligence is particularly important in private company acquisitions, because the seller has not undergone the scrutiny of the public markets and of registering its securities with the SEC.  So the buyer has no public sources of information on the seller.

For the seller, an internal due diligence is important to identify liabilities that can diminish the company’s value, such as lawsuits, governance irregularities, operational irregularities, third party consent requirements or events of default.

Also, if the seller is receiving buyer stock as a form of payment, or the deal is a merger of equals, then the seller should conduct its own due diligence of the buyer as well.