Due Diligence refers to an exhaustive process of research, analysis and evaluation that is carried out before making an investment, acquisition, merger or any other type of major business transaction.

It is a critical procedure for obtaining information about the risks, opportunities and the true value of a company or asset under consideration.

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In a nutshell, Due Diligence consists of research or auditing that examines in detail the different areas of a company to determine if complies with its obligations and there are no potential contingencies or legal risks substantial derivatives derived from their activity.

When is Due Diligence necessary?

In the entrepreneurial ecosystem, the concept of Due Diligence is very common when companies start raising funding rounds. In very early stages, when companies access external funding through sources known as 3F or Business Angels, formal Due Diligence is usually not necessary. However, although these types of investments are based on personal relationships and trust between the parties involved, it is important that investors are informed and understand the relevant aspects of the company before investing. However, it is recommended that the entrepreneur provide clear and transparent information about the company from the outset, including financial aspects, business objectives and potential risks.

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Later, when the company has the capacity to raise funding through professional Business Angels or Venture Capital firms, Due Diligence plays a crucial role in this process, helping to assess the risk involved in the investment opportunity and to obtain a comprehensive understanding of the commercial, economic, fiscal and legal situation in which the company in question finds itself.

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Although performing Due Diligence is not required by any law, as we move into the information age, the concept of due diligence has become even more relevant and necessary. Companies are faced with a large amount of data and sources of information (for example, in the case of payment methods that have proliferated strongly in recent years), which makes the collection and analysis process even more challenging, so future investors in the company will need to be able to verify that the accounting closures, metrics and other information and financial statements presented to them about the company are true and contain information that faithfully reflects the state of the company.

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And something similar happens before an acquisition, merger or sale of a company. In this type of process, carrying out due diligence allows us to evaluate the viability of the transaction and detect the possible risks associated with it. In addition, there are startups that carry out a Internal Due Diligence that allows them to identify potential weaknesses and areas for improvement in their business before presenting themselves to potential investors or partners. This process of research, analysis and evaluation, carried out by the management team and other experts in the entrepreneurial ecosystem, can be essential to ensure the strength of the company. Internal due diligence helps startups detect and resolve operational problems before they affect their growth and profitability, allowing them to present themselves to investors with a solid proposition and a well-defined strategy.

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Why is it important?

There comes a time when, as we have already mentioned, carrying out Due Diligence is of vital importance both for the company's future investors and for the company itself, since it provides a series of significant benefits and helps to make informed decisions. On the one hand, Due Diligence allows identify hidden risks which may not be obvious to the naked eye. By thoroughly analyzing financial, legal, fiscal and labor aspects, potential problems can be discovered, such as hidden debts, pending legal disputes, operational deficiencies or regulatory breaches. In addition, carrying out a process such as this type of analysis helps to learn about existing opportunities in the market. During Due Diligence, the company's target market and competitive position are analyzed, allowing potential growth opportunities, underserved market niches, competitive advantages and emerging trends to be identified. By better understanding the business environment, strategic decisions can be made to take advantage of these opportunities and increase competitive advantage.

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Finally, Due Diligence helps to perfect the understanding of the company's business model, by analyzing aspects such as organizational structure, operational processes, business strategy and human resources. On the other hand, after a Due Diligence process, the company's future investors will be more clear about real value of the business and its long-term projection. Due Diligence provides a comprehensive evaluation of the company, including its financial statements, assets, liabilities, cash flow and future projections. Investors and stakeholders can use this information to make decisions about the valuation of the company and assess whether the investment is viable and profitable. By providing detailed information about the company, its financial performance and its growth potential, trust can be built with investors and creditors, which can result in better financing terms and conditions.

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What does Due Diligence include?

Due Diligence includes tests at 4 levels or areas of the company: legal, financial, fiscal and labor. Without intending to be exhaustive, we then explore the main documents that should be subject to scrutiny in such an intervention.At the financial levelIt should be noted that finances in a company are key to the success and growth of any organization and serve several purposes. Among them:

• Manage financial resources efficiently and effectively In addition, having well-organized finances avoids the dreaded sense of chaos in the company.‍
• Make strategic decisions that improve the company's profitability and growth. From which items should the costs be lowered? What strategies should be activated to increase sales? , etc. ‍
• Evaluate the company's financial performance and make adjustments as needed.
• Assess financial risks and develop strategies to mitigate them
• Obtain funding for company operations and investment projects. As we have mentioned before, having an orderly finances gives future investors security. If a company is not clear about its finances and does not know how to determine what its main metrics are, no matter how good the team is and the project fits the investment thesis, it will not be suitable for investment.

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Therefore, in the financial part of Due Diligence, aspects such as:

• Financial Statements: such as the balance sheet, income statement, cash flow statement and explanatory notes.‍
• Audit reports: external audits or internal audit reports.‍
• Accounting policies and procedures: documentation that describes the accounting policies and methods used to prepare the financial statements.‍
• Contracts and agreements: contracts with customers, suppliers, leases, distribution agreements, employment contracts, among others.‍
• Debts and financial obligations: bank loans, lines of credit, promissory notes, financial lease agreements, among others.‍
• Bank account statements: bank statements, bank reconciliation, investment account information, and others.‍
• Information from customers and suppliers: list of major customers and suppliers, relevant contracts, business terms and conditions.‍
• Tangible and intangible assets: inventory, property, machinery, equipment, intellectual property, trademarks, patents, and others.‍
• Insurance Information: current insurance policies, coverage, past claims, insured risks.

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At the legal level. This includes aspects such as:

• The relationship between shareholders. What percentage does each of the founders have?
• ‍ The Acts and the Scriptures: What type of scriptures are they? , How many people are or have been involved in the company? Are the minutes of approval of annual accounts in order? , etc. ‍
• The contracts signed by the company: What types of contracts are signed with customers? , What type of contracts are signed with suppliers? , etc. ‍
• Administrative aspects: Is the company registered correctly in the register? , Does the board of directors exist? Are contracts with suppliers clear? , etc. Aspects about unions, partners, etc. should also be included at this point.‍
• Contentious and data protection issues: This is a very important topic, especially today, since it is mandatory for all companies, regardless of the stadium or sector in which they operate.
• ‍ Partner agreement: It is essential to be clear about all existing relationships in the company and the role of each one. The pact will vary depending on both the type of companies and their stadium.

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*Patents can be included in both the legal and financial aspects of Due Diligence, since it is important to see their value on the balance sheet (since they are an asset of the company).

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‍At the fiscal level. It is important to take into account, depending on the type of company, the three most important taxes:

• Tax returns: personal income tax (IRPF) and corporate (IS) tax returns, value added tax (VAT), corporate tax, and other applicable taxes.‍
• Tax payments: documentation supporting tax and withholding payments made.‍
• Tax Accounting: specific accounting records for tax purposes, such as VAT registration books, investment asset registration books, registration books for intra-community transactions, among others.‍
• Resolutions and agreements with the Tax Administration: resolutions, agreements, agreements or any other documentation related to past or ongoing inspections, tax adjustments, controversies or litigation with the Tax Administration.‍
• Tax benefits: documentation supporting the tax benefits or incentives applied, such as deductions, bonuses or tax exemptions.‍
• Withholding and on-account payments: withholding and account income records, such as withholding income from work or fractional corporate tax payments.‍
• Transfer pricing regime: documentation related to transactions carried out between related parties, such as transfer pricing contracts, comparability studies, analysis of functions, assets and risks, among others.‍
• Tax debts: information about outstanding tax debts, deferral or installment agreements, ongoing tax-related claims or litigation.‍
• Tax Certificates and Notifications: certificates of being up to date with tax obligations, notifications from the Tax Administration, requirements, provisional or definitive liquidations, among others.‍
• Documents related to specific operations: fiscally relevant documentation related to acquisitions, mergers, restructurings, transfers, intra-community transactions, imports or exports, among others.

It is important to check if the company is up to date with all its tax obligations, both with Doing and with Social Security.

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‍At the Workplace Level. This includes aspects such as:

• Employment contracts: copies of employees' employment contracts, including any additional contracts or amendments.‍
• Payroll and wage records: employee payroll and wage payment records, including a breakdown of wage concepts, withholding, social security contributions, overtime, etc.‍
• Benefits and Compensations: documentation on additional benefits offered to employees, such as health insurance, pension plans, stock option plans, incentives, etc.‍
• Work Policies and Procedures: employee handbooks, human resources policies, codes of conduct, internal regulations, occupational risk prevention protocols, etc.‍
• Employee records: personal records of employees, including documentation related to hiring, training, promotions, disciplinary sanctions, casualties, etc.‍
• Licenses and permissions: documentation supporting the licenses and permits granted to employees, such as maternity/paternity leave, sick leave, special leave, etc.
• ‍ Labor inspections: reports of previous labor inspections, sanctions or fines imposed, requirements or claims pending resolution.‍
• Outsourcing: documentation related to the contracting of external services or outsourcing, temporary employment contracts, contracts with temporary employment agencies, contracts with external service providers, etc.‍
• Confidentiality and non-competition agreements: confidentiality and non-competition contracts signed by employees.‍
• ERE or collective redundancies: documentation related to employment regulation files, collective dismissals, severance payments, exit agreements, etc.

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In conclusion, due diligence is a crucial process that plays a fundamental role in making informed business and financial decisions. Through extensive research and analysis, the risks and opportunities associated with a specific transaction or decision are evaluated. Due diligence encompasses the review of relevant financial, legal, tax, and labor documents to ensure a full understanding of the circumstances and mitigate potential risks. The objective is to discover any hidden problems or contingencies, identify opportunities for improvement and understand the true nature and value of the transaction in question.

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Due diligence allows informed decisions to be made, whether to carry out an acquisition, investment, strategic alliance or any other relevant business activity. By knowing the risks and benefits in detail, surprises are minimized and the basis for a successful transaction is established. It is a process that requires the participation of multidisciplinary experts and a rigorous approach, but the benefits it offers in terms of security, protection and maximization of opportunities are invaluable.