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How much due diligence is necessary before signing a contract?

On Behalf of | Jun 25, 2023 | Business Law |

Any business decision features some degree of risk. Whether a company is about to hire a new executive for a major rebranding or sign a new lease for manufacturing space, there will be risks for the business inherent in the transaction in addition to the benefits the company stands to receive.

Due diligence before a transaction requires an understanding of the possible risks inherent in the transaction and a review of the circumstances. It is only when the leadership at an organization truly understands the impact of a decision that the company can pursue the best choice possible. Due diligence could be as simple as reviewing paperwork provided by the other party or be incredibly involved. How do executives determine how much due diligence is necessary for an upcoming transaction?

They balance the risk with the costs

There is no one answer about the correct amount of due diligence for business transactions. The perfect amount of due diligence is just enough to uncover major issues that would put a company at risk, but how much research that requires would be very different depending on the circumstances.

For example, it might take interviews with staff members to discover that a merger would be a bad idea because the company may soon face a discrimination lawsuit. Looking beyond just a resume and the records turned up in a background check will often be necessary if a new hire will play a key role at the company, as their misconduct could have left no paper trail. The more risk the company has in a transaction, the more it may need to invest in investigations beforehand.

However, when hiring a customer service representative or signing a contract with a new vendor, simply performing a basic background check and reviewing the materials provided by the other party may be sufficient given the reduced level of risk involved in those smaller transactions. Bigger transactions that result in more risk and exposure for organizations require more careful review, but even then, the company may need to set a limit on how much it will invest.

Especially when a transaction or contract could potentially alter the future of the organization, as would be the case with mergers, acquisitions and new leadership, extensive due diligence is often necessary. Many executives, business owners and board members concerned about a business transaction may want to bring in outside help to assist with fulfilling the due diligence requirement.

Reviewing contracts and business records with a lawyer can be an important form of due diligence prior to a major business decision.