It is what must be done to avoid civil suites for negligent actions. It includes the obligation to offer protection whenever there would be risk of actual circumstance differ from anticipated or planned circumstances.
It is most commonly thought of in terms of financial investigations, where it is the verification of representations and claims made by one party to another in an economic transaction. Financial due diligence process is not just verifying facts that have been disclosed, but uncovering those that have not.
Financial due diligence is particularly important in business transactions in emerging markets, since there is s much higher risk of misrepresentation, fraud, corruption and criminal activity.
In any investigation, you need to bring with you a basic understanding of the entities you are likely to encounter. The following is a summary of the common business entities.
Sole Proprietorship A sole proprietorship (also known as a “Schedule C business”) is wholly owned by one individual. The characteristics of a sole proprietorship are:
- The owner has unlimited liability.
- The owner (rather than the entity) pays income tax.
- The sole proprietorship has a limited life.
- Assets of the sole proprietorship are held in the owner’s name.
General Partnership A general partnership is an entity created by agreement (oral or written) between two or more parties to combine assets, labor, and/or skills in a business, and to share the profits and losses there from. Profits and losses do not have to be shared equally. The characteristics of a general partnership are:
- The partners have unlimited personal, joint, and several liability.
- The partners pay income tax on earnings of the partnership.
- The partnership has a limited life.
- The partners have a right to bind the partnership and/or the partners by their individual acts (absent agreement to the contrary).
- Each partner’s equity is reflected in his partnership capital account.
Limited Partnership A limited partnership is an entity created by written agreement, having at least one general partner and one limited partner. The characteristics of a limited partnership are the same as those of a general partnership; however, there are two significant differences.
- The limited partners liability is limited to the investment in the partnership.
- Each limited partner’s interest in the partnership is freely transferable.
Corporations-Regular and Subchapter S A corporation is an entity created by state law; ownership, is evidenced by shares of stock. The characteristics of a corporation are:
- There is limited shareholder liability.
- The corporation has an unlimited life.
- The rights of the shareholders are determined by state law and the corporate bylaws.
- The corporation has centralized management (which may be held liable for actions taken by the corporation at their direction).
- The corporation has free transferability of ownership interest. In some corporations there may be limitations on the transferability of the stick shares; e.g. a co-op.
A corporation is generally taxed at a rate separate from that of individuals. If the shareholders of a company elect to be taxed under subpart S of the Internal Revenue Code (”S Corporation”); the shareholders are taxed directly on their proportionate share of the company’s total profits of losses.
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