What Is Due Diligence?

Nicholas J Price
5 min read

The term due diligence gets thrown around a lot without people thinking very much about what it means. The dictionary gives the term due diligence a basic meaning. Depending on the context in which the term is used, it can hold other meanings, as it does in relation to boards of directors.

Merriam-Webster provides a definition for due diligence as it pertains to business. The definition cites 'research and analysis of a company or organization done in preparation for a business transaction (such as a corporate merger or purchase of securities).'

Black's Law Dictionary cites the following definition for due diligence: 'Such a measure of prudence, activity, or assiduity, as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent man under the particular circumstances; not measured by any absolute standard, but depending on the relative facts of the special case.'

When considering due diligence, it's important to consider its application. As the term pertains to boards of directors, prospective board directors should consider how it applies to them prior to joining a board, as well as after they join a board.

What Is Due Diligence?

The essence of the meaning of due diligence is being thorough. In the general business sense, due diligence means vetting issues that affect the business thoughtfully and carefully. Due diligence means to be proactive, rather than reactive, in response to problems.

Businesses need to have written policies and procedures in place. Certain issues may be better addressed by using a checklist to ensure that groups or individuals are giving the issues the proper amount of time and attention. In addition to having guidance in written form, due diligence calls for boards to cooperate and collaborate with others.

Diligence requires boards having access to management as necessary without micromanaging them. Certain situations may call for expertise that the board doesn't have within its ranks. Under certain circumstances, due diligence may mean seeking and obtaining outside expertise from attorneys, accountants, insurance agents, financial experts, tech experts or other individuals with professional or special expertise.

Carrying Out Due Diligence Prior to Joining a Board

Serving on a board of directors can be a personally and professionally rewarding experience. In bringing new directors into the boardroom, it's just as important for prospective board directors to carry out their due diligence as much as it is the board's responsibility to perform due diligence in recruiting the best candidates.

Board service inherently brings some risks with it. Group processes and group dynamics can sometimes be difficult to navigate. Boards make decisions and speak with one voice, which means that board decisions are group decisions. Board directors must have loyalty to the board, which can generate personal risks when individual board directors privately disagree with board decisions but must publicly agree with them. Directorship risk refers to each board director being jointly liable for all board decisions and actions.

For prospective board directors, due diligence should begin before they accept a position on the board. It's the best time to gather information about the board and the other directors. Incoming board directors need to learn about the board's processes, commitments and internal dynamics before they become an integral part of the process. It's best to learn early on what to expect and whether they'll be a good fit.

What Is Due Diligence for Board Directors?

Due diligence for board directors encompasses many things.

One of the primary matters that relates to due diligence for board directors is fiduciary duties. Fiduciary duties are present in nearly every board director's actions and decisions. They are well-known expectations for board directors and other individuals who serve in leadership positions. For board directors, fiduciary duties pertain to the duty of care, the duty of loyalty and the duty of obedience.

Duty of care is a legal obligation for board directors that requires them to give their actions and decisions the same care and attention that any normal, prudent person would. Duty of loyalty means that board directors must place the interests of the company and its shareholders and stakeholders above their own. Duty of obedience most closely relates to compliance issues. Board directors must at all times ensure that their actions and those of the company or organization they represent comply with federal, state and local laws, as well as any applicable regulations.

Beyond being dutiful with their fiduciary responsibilities, exercising due diligence requires board directors to do their best to have good attendance at board and committee meetings and to actively participate in them.

The goal for corporations and nonprofits is to plan for how to move their organizations forward and make them productive and profitable. For-profit corporate boards focus much of their time and energy on financial reports. Due diligence for these boards requires them to study annual reports and Securities and Exchange Commission (SEC) filings. They also need to identify the company's risk tolerance and to develop a risk management plan. Board directors need to exercise due diligence in assessing their income needs and how to best allocate their resources and assets.

In dealing with merger and acquisition scenarios, boards must exercise due diligence in carefully reviewing and verifying all aspects and material facts of another company's investments.

Essentially, due diligence tells board directors where the company is headed currently and for the future.

Diligent Corporation developed Governance Cloud, which is a suite of fully integrated board software solutions, with the goal of assisting board directors in their responsibilities for due diligence. Governance Cloud provides software solutions for boards with everything from meeting agendas and minutes, to D&O questionnaires, streamlined electronic voting tools and a secure communication platform. Diligent also offers virtual data rooms for privacy during mergers and acquisitions. Governance Cloud was designed with board efficiency in mind, which provides boards with the time they need to ensure due diligence in good corporate governance.

In closing, due diligence is a common term and board directors need to fully understand its meaning and its proper context. Due diligence for board directors begins during the time of recruitment and is equally important with every board action and interaction. Board directors who make due diligence a priority reduce their own risks and set the course for a rewarding board director experience.