What is due diligence (DD) anyway?
In the world of penny stocks, DD is widely misunderstood to be all of the great things that are claimed to be happening or supposedly will be happening. Usually these "great things" are unverified and typically are never able to be verified or ever come to fruition (regardless of the stock). This kind of information is hype, not DD.
In reality, DD is an important verification and risk assessment function which is legally required in certain circumstances. DD seeks to verify all material claims made by the company including its financial statements, press releases, etc., considers the financial stability of the company and ability to achieve its business plan, vets the officers and directors, reviews the past and present performance of the company, etc., in order to make informed decisions about an investment initially and whether to continue to hold after buying in.
DD regarding a stock investment needs to be continuously performed over time, particularly a penny stock. It can be difficult to do DD on a company with a limited history. However, as time passes, the ability to perform verification and risk assessment DD improves. Often (probably usually), penny stock investments don't live up to their initial hype. Over time when the "great things" fail to materialize and the company has to dilute to stay in business, the stock price declines and often becomes illiquid as new investors are able to assess the past history of failed expectations.
Information and links regarding due diligence:
Due Diligence Definitions
1. General: Measure of prudence, responsibility, and diligence that is expected from, and ordinarily exercised by, a reasonable and prudent person under the circumstances.
2. Business: Duty of a firm's directors and officers to act prudently in evaluating associated risks in all transactions.
3. Investing: Duty of the investor to gather necessary information on actual or potential risks involved in an investment.
4. Negotiating: Duty of each party to confirm each other's expectations and understandings, and to independently verify the abilities of the other to fulfill the conditions and requirements of the agreement. Also called reasonable diligence.
Definition of 'Due Diligence - DD'
1. An investigation or audit of a potential investment. Due diligence serves to confirm all material facts in regards to a sale.
2. Generally, due diligence refers to the care a reasonable person should take before entering into an agreement or a transaction with another party.
Investopedia explains 'Due Diligence - DD'
1. Offers to purchase an asset are usually dependent on the results of due diligence analysis. This includes reviewing all financial records plus anything else deemed material to the sale. Sellers could also perform a due diligence analysis on the buyer. Items that may be considered are the buyer's ability to purchase, as well as other items that would affect the purchased entity or the seller after the sale has been completed.
2. Due diligence is a way of preventing unnecessary harm to either party involved in a transaction.
Due diligence by Angels (applies to investors in public stock as well:
Due diligence is the routine process by which investors diligently investigate the entrepreneur and his/her company to confirm the authenticity of a business endeavor. This may entail researching business founders and their management team, reviewing documents, endless amount of questions, and asking for references. In a recent study conducted by the University of New Hampshire’s Center for Venture Research, angels who practiced increased due diligence received more overall profitable returns. Experience has also shown that without performing detailed research to verify an investment prospect, an investor is taking a significant risk.
What is Due Diligence?
Due diligence is used to investigate and evaluate a business opportunity. The term due diligence describes a general duty to exercise care in any transaction. As such, it spans investigation into all relevant aspects of the past, present, and predictable future of the business of a target company.
Why is Due Diligence Conducted?
There are many reasons for conducting due diligence, including the following:
* Confirmation that the business is what it appears to be;
* Identify potential "deal killer" defects in the target and avoid a bad business transaction;
* Gain information that will be useful for valuing assets, defining representations and warranties, and/or negotiating price concessions; and
* Verification that the transaction complies with investment or acquisition criteria.