Due diligence generally means the careful analysis and evaluation of an object in a business context. Due diligence checks are carried out in particular in the context of upcoming transactions such as company acquisitions. In connection with the Money Laundering Act, customer due diligence checks and the careful examination of new and existing customers are a central part of fulfilling the duty of care
Due diligence is a verification process during which strengths, weaknesses, opportunities and risks are analyzed, taking into account economic, legal, tax and financial circumstances. The goal is to uncover all potential risks that may arise from a business relationship.
Why Are You Doing Due Diligence?
Due diligence is a complete background investigation by which companies use various sources of information to protect themselves from potential counterparties. This helps companies protect their interests and avoid potential risks. The grounds for conducting a comprehensive audit may be:
Prevention of Money Laundering and White-Collar Crime
Business Associate Due Diligence is a central component of the due diligence requirements under the Money Laundering Act (AMLA).
Mergers and Acquisitions / M&A Activities
Prior to mergers and acquisitions, such as acquisitions, takeovers or participations, an external consultant usually performs due diligence. This makes sense for both the buyer and the seller. With the buyer’s due diligence, the buyer initiates a review to assess the risks and opportunities of the purchase. Findings are usually included in the purchase price offer. As part of the Seller’s Due Diligence, the Seller orders a system analysis to eliminate any weaknesses in advance, as well as to prepare sales negotiations.
Reputational Damage Prevention
Before a collaboration, companies often screen business partners for ethical and legal compliance when selecting potential business partners. The goal is to detect wrong actions in advance to avoid reputational damage.
Specific recommendations for further action may be obtained based on the results of the due diligence check: for example, a business risk may be reassessed with a client, or it may be recommended not to establish a business relationship.
What is checked during due diligence?
The areas to be tested vary depending on the purpose for which the due diligence is carried out. This leads to functional forms of due diligence. This includes:
Customer Due Diligence (CDD): Checking new and existing customers for money laundering in accordance with the Know Your Customer (KYC) principle.
Financial due diligence: checking all commercial areas such as accounting, annual financial statements, control, financial relations and payment flows.
Commercial expertise: the study of business activity and relations with the business environment and the market.
Legal Due Diligence: verification of all internal and external legal relations to identify legal risks for the company’s performance.
Intellectual Property Due Diligence: Reviewing a company’s intellectual property (IP) such as patents, trademarks, and licenses.
How does customer due diligence comply with the Money Laundering Act?
The Money Laundering Act (GwG) is designed to prevent illicit money flows from entering the business cycle. Achieving this goal requires a thorough due diligence of the business partner or customer. Mandatory companies under the GwG – these include financial companies, auditors, notaries, real estate agents – must regularly screen their new and existing clients. Customer due diligence focuses on the following areas, among others:
- counterparty identification;
- audit of representative bodies and ownership and control structure;
- clarification of the beneficial owner;
- checking the status of a politically exposed person and sanctions lists, as well as other risk factors.
The identification and verification of business partners to prevent money laundering is also known as Know Your Customer (KYC) verification.