A Quick Guide to Vendor Due Diligence

October 18, 2022
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A Quick Guide to Vendor Due Diligence

When you own a business, every decision you make is important — from the people you hire to the tools you use to the ways you build and deliver your product to customers. One of these decisions that can massively impact your business is which vendors you choose to partner with.

On the surface many business leaders assume the quality of a vendor's products and the competitiveness of their prices are the only two factors worth considering. But working with a vendor isn’t as simple as paying for a straightforward service or product. When something goes wrong, the importance of the vendor due diligence process becomes painfully clear. This is why it’s important to choose business relationships as carefully as personal ones. 

This guide provides an in-depth look at vendor due diligence and its benefits — and a helpful vendor due diligence checklist to help you get started.

  • What Is Vendor Due Diligence?
  • Why Is Vendor Due Diligence Important?
  • How To Conduct Vendor Due Diligence
  • Vendor Due Diligence Checklist
  • The Importance of Ongoing Vendor Due Diligence 
  • Benefits of Vendor Due Diligence

What Is Vendor Due Diligence?

Vendor due diligence (also known as vendor risk assessment) is the practice of assessing a potential vendor to ensure that they will be a reliable and beneficial partner for your business. While this may sound straightforward, there's more to the due diligence process than first meets the eye. You need to consider factors such as reputational risk, operational risk, and cyber risk before you can feel confident about partnering with a new vendor.

When you partner with a vendor, you stake your company's success to that vendor in more ways than one. For example, if your accounting vendor experiences platform downtime, you may be left without access to critical billing or payroll information. Proper due diligence ensures that your vendors strengthen your company rather than dragging it down.

Why Is Vendor Due Diligence Important?

Great vendor relationships are valuable assets for any company, while poor vendor relationships can prove incredibly costly. There's no way to know which vendor will be the best partner for your company without doing your homework first.

Proper vendor due diligence offers benefits such as:

Protect Your Organization From Vendor Risk

Vendor risk can come in many forms — from data breaches that expose your company's sensitive information to extended downtime that prevents your company from procuring the materials it needs to remain operational. You can never eliminate these risks entirely, but you can mitigate them by choosing trustworthy and reliable vendors who have a track record of success.

Protect Customers' Sensitive Information

It isn't just your company's sensitive data that you put at risk when you partner with the wrong vendor. In many cases, you may also be putting your customers' and employee’s data at risk as well. In 2021 alone, 212.4 million people in the United States were affected by data breaches — that’s more than two-thirds of the entire U.S. population.

Needless to say, your customers won't be very happy if they purchase from your business and their credit card information (or other sensitive data) gets stolen. This makes it essential to partner with vendors who take cybersecurity seriously.

Increase Prospect's Trust and Confidence

Not all customers will take the time to check out which vendors you partner with before they purchase from your company, but larger enterprises and security-minded organizations definitely will. Partnering with reputable, trustworthy vendors increases the trust and confidence of potential customers, making it easier for you to close the deal.

How To Conduct Vendor Due Diligence

The easiest (and most effective) way to conduct vendor due diligence is to use an automated due diligence questionnaire. You can use a simple questionnaire template and automatically send it to vendors for a vendor risk assessment, making this an easy and efficient way to get the job done. With a questionnaire, you eliminate the tedious process of analyzing each vendor manually and ensure that you can perform your due diligence at scale for each and every vendor you consider.

To learn more about automated due diligence questionnaires and to see a free questionnaire template, check out this resource from HyperComply.

Vendor Due Diligence Checklist

No matter how you perform a risk assessment, there are several important factors to consider. Here is an in-depth vendor due diligence checklist that will help you identify potential risks and vulnerabilities in various forms.

1) Collect Company Information

Before you move forward with a vendor, you should collect basic company information, including:

  • Vendor's business certificate or license
  • Incorporation documents
  • References from some of the vendor's customers
  • Basic information on the vendor's CEO and other executives/board members
  • An overview of the vendor's corporate structure

Though you will likely need to dig deeper as you evaluate a vendor, this basic company information will be the foundation for the rest of your vendor risk management process.

2) Identify Inherent Risk

Inherent risk is defined as the risk that a vendor poses before your company takes any mitigation steps. Consider the following when trying to determine a vendor’s inherent risk:

  • How easily can you replace the vendor if something goes wrong?
  • How much data (and what type) will you share with the vendor?
  • What’s the scope of your engagement and how critical is this vendor to your business operations?

Poor cybersecurity practices, operational inefficiencies, and poor financial posture are all examples of inherent risk, and it's important to identify them right out of the gate. 

3) Assess Financial Risk

If the vendor you partner with goes belly up or suddenly has to lay off key team members, your company might be left hanging. This makes it important to carefully assess a vendor's financial information to ensure bankruptcy isn't on the horizon. To assess the vendor’s financial risk, ask to see their:

  • Tax documents
  • Loans or other financial liabilities
  • Assets
  • Balance sheets

4) Evaluate Operational Risk

Operational risks are those inherent in a vendor's operations. For instance, a vendor located in a hurricane-prone location will be at risk of weather-related downtime. A vendor that relies on an overly complex supply chain might be at risk of downtime due to supply chain disruption. Inquire about the following to help you evaluate a vendor's operational risk:

  • Business continuity plan
  • Disaster preparedness plan
  • Employee lawsuits
  • Code of conduct

5) Determine Reputational or Political Risk

If it comes to light that your company has partnered with a shady vendor, your customers are going to have something to say about it.

Beyond potentially damaging the reputation of your own company, partnering with vendors with a shady reputation can also directly lead to disruption. Sanctions and lawsuits can upend a vendor's operations and leave your company out to dry if you partner with a vendor who is vulnerable to such things. Here are a few helpful tools to help determine a vendor’s reputational risk:

  • News reports
  • Negative company reviews from customers
  • Reviewing vendor’s personnel and key stakeholders to identify politically exposed persons (PEP)
  • Stakeholder litigation histories

6) Examine Legal Risk

Legal risk ties closely to reputational and political risk. While your company might not be held directly responsible for the illegal actions such as fraud or money laundering that one of your vendors takes, those actions can still negatively impact your company. Be on the lookout for:

  • Pending or past lawsuits 
  • Active or prior compliance violations

7) Analyze Cybersecurity Risk

Over 450,000 new malware crop up every day, making data breaches a clear and present danger that every company needs to protect itself against. Even if your company's cybersecurity tools and practices are rock solid, your sensitive data could still be exposed if you provide it to vendors who do not take cybersecurity seriously. This makes it essential to assess vendors based on their compliance with accepted cybersecurity standards like ISO 27001. Ask the vendor for the following:

  • History of data breaches
  • Penetration test results
  • Compliance reports (ISO and SOC 2)
  • IT systems diagram

The Importance of Ongoing Vendor Due Diligence

Nothing in business is static — including the risk that a vendor poses to your company. Mergers, changes in management, and changing business or political environments are just a few examples of ways a vendor (and your relationship with them) can change over time. While it's important to spend plenty of time onboarding new vendors, it's equally important to assess your existing vendors on an ongoing basis to ensure that new risks don't go unnoticed. With ongoing monitoring, you can ensure that your vendors remain strong, reliable partners.

Benefits of Vendor Due Diligence

Vendor due diligence and a proper risk management program offer several considerable benefits, including:

Uncover Risks Beforehand

An ounce of prevention is worth a pound of cure. Even if you decide to move forward with a vendor after a risk has been uncovered, it's still much better to be aware of that risk beforehand so that you can prepare accordingly.

Ensure a Stronger and Smoother Process

Knowing potential risks beforehand enables you to discuss them with the vendor and implement mitigation measures. This ensures a stronger and smoother process where vulnerabilities are addressed ahead of time — rather than dealing with them in real time when (and if) they rear their ugly heads.

Negotiate Better Deals

In the same way that noticing a dent on a used car might enable a potential buyer to haggle for a lower price, uncovering a vendor's shortcomings can sometimes prove valuable when it's time to sit down at the negotiating table. If an issue that you discover isn't a dealbreaker, you can still use it as leverage to negotiate a better price. Just be careful how you go about this: No one likes to have their weak spots pointed out, and you don't want to make potential vendors feel like you're unethically manipulating them.

Improve and Maintain Business Relationships

Vendor due diligence helps companies avoid issues that could otherwise upend business relationships. Discovering issues and vulnerabilities after the fact is a bad time for everyone involved and certainly isn't a recipe for solid vendor relationships. Business relationships are far stronger when everything is transparent and above board.

Streamline Your Vendor Due Diligence With HyperComply

Vendor due diligence is vital for any company that relies on third-party vendors. However, it's also sometimes a tedious and confusing process. At HyperComply, we make vendor due diligence easier and more reliable than ever before with automated due diligence questionnaires. Start leveraging HyperComply today to make sure that your vendors aren't your company's weak link.