What Is Due Diligence? A Guide for Businesses and Capital Providers

Before a lender provides a loan, an investor commits capital, or a company enters an important partnership, they must first establish who they are dealing with and whether the information they have can be trusted.

For an African SME seeking funding or entering an important business relationship, this means being able to substantiate the information that decision-makers need to assess the business. A business may have a promising product, strong revenue, or ambitious growth plans, but those claims only carry weight when supported by reliable information and evidence.

That is where due diligence comes in.

Due diligence helps decision-makers investigate and verify the information they need before committing funds or capital, entering a business relationship, or taking on significant risk. For a business, it can mean showing that its ownership, financials, operations, and other important claims are supported by evidence. For a lender or investor, it provides a structured way to assess the business before deciding.

Beyond what due diligence is, what exactly does due diligence involve, why does it matter, and what should businesses and capital providers know before starting the process? Let's break it down.

What Is Due Diligence?

At its core, due diligence is about establishing the facts before making a decision. The process involves gathering relevant information, checking it against available evidence, identifying inconsistencies or gaps, and assessing what those findings mean for the decision at hand.

The depth of the process depends on the situation. A lender assessing a small business for financing may need to understand its revenue, cash flow, existing obligations, ownership, and ability to repay. An investor considering an equity investment may need a much broader view covering the company's finances, market, customers, operations, legal position, ownership structure, and growth prospects.

This is why there is no universal due diligence checklist that works for every business or transaction. The right checks depend on what is being assessed and the risks associated with the decision.

🔗Also read: The Business Funding Lifecycle: What Happens Before, During and After a Business Gets Funded.

What does business due diligence cover?

The areas examined during due diligence depend on the business, the transaction, and the risks involved. However, a thorough assessment can cover several parts of a business, from its identity and financial position to its operations, legal standing, commercial activity, and credibility.

Business identity and ownership

The first step is establishing who the business is and who is behind it. This can include verifying its legal name, registration details, operating status, business location, directors, shareholders, and beneficial owners. These checks help confirm that the business exists as presented and establish who owns and controls it.

Financial position

Financial due diligence examines the business's financial health and performance. Depending on the purpose of the assessment, this may include revenue, expenses, profitability, cash flow, assets, liabilities, bank statements, financial statements, tax records, outstanding debt, and financial projections.

The objective is not simply to determine whether a business is profitable. It is to understand how it generates and manages money, and whether its financial position supports the proposed transaction.

Legal and regulatory standing

Legal due diligence looks at obligations, disputes, and other issues that could affect the business or the transaction.

This may involve checking business registrations, licences, permits, contracts, litigation, regulatory compliance, intellectual property, employment obligations, and other legal matters relevant to the business. For businesses operating in regulated industries, these checks can be particularly important because regulatory issues can affect their ability to operate or fulfil their obligations.

Commercial activity

Commercial due diligence focuses on how the business makes money and competes in its market. A capital provider may examine the business's products or services, customers, suppliers, competitors, pricing, revenue sources, customer concentration, business model, market position, and growth opportunities. This helps determine whether the business's commercial activity supports its claims about performance and prospects.

Operations

Operational due diligence looks at how the business functions day-to-day. This can include its people, processes, technology, physical assets, supply chain, internal controls, and capacity to deliver its products or services. A business can have strong financial performance while still carrying operational weaknesses that could affect its ability to grow, serve customers, or meet its obligations in the future.

Reputation and credibility

Financial statements and business documents provide important information, but they may not tell the whole story. Depending on the decision being made, external information can provide additional context about the business. This might include its business history, relationships, public records, previous activity, and other available evidence that can confirm or raise questions about information provided by the business.

Ultimately, the goal is not to assess a business based on reputation alone. It is to bring together relevant evidence from different sources so the decision-maker can develop a more complete view of the business.

How the pieces fit together

Due diligence becomes more useful when the information from each area is considered together rather than in isolation.

For example, a business may report strong revenue growth. On its own, that may look like a positive sign. But further checks could show that most of the revenue comes from a single customer, that cash flow has not grown at the same rate, or that the business has not expanded its operational capacity enough to support its reported growth.

These findings do not automatically mean the business is unsuitable for funding or partnership. They give the decision-maker more context and may raise questions that need to be answered before a decision is made.

This is ultimately what due diligence is designed to do: reduce uncertainty. It brings together information from different parts of a business to help decision-makers understand what they are considering, identify potential risks, and determine whether they need more information before proceeding.

Is due diligence only for investors?

No. Due diligence applies to many business decisions where one party needs to understand and assess another business.

A lender may conduct due diligence before approving financing. A company may assess a prospective supplier before signing a major contract. A business may investigate a potential partner before entering a strategic relationship. An acquiring business may conduct extensive due diligence before purchasing another business.

The specific checks will vary depending on the decision, but the underlying need is the same: decision-makers need reliable information about the business they are considering working with.

Conclusion

Good due diligence depends on good information. But getting that information together can be time-consuming and labour-intensive. Capital providers may need to gather data from multiple sources, manually review documents, verify claims, and piece together findings before they can form a clear picture of a business.

And that picture can change. Businesses change over time. Financial performance can shift, ownership can change, new obligations can emerge, and the way a business operates may look different from when it was first assessed.

For African SMEs, this creates a two-sided challenge. Capital providers need reliable information to assess businesses they may not know well. Businesses, meanwhile, need to demonstrate who they are, how they operate, and whether their claims about their business are supported by evidence.

That is the gap Acreed Insights is addressing. Acreed provides credibility intelligence for Africa, using continuous, verifiable data to help capital providers make more informed decisions and businesses build a credible, verifiable record over time.

For capital providers, that means a clearer view of the businesses they assess. For businesses, it means building a credible record that can support future funding and growth opportunities.

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