Essential Guide to Effective Third-Party Due Diligence Practices

Essential Guide to Third-Party Due Diligence

Modern organizations operate through a complex web of vendors, suppliers, contractors, and service providers. These partnerships enable innovation, efficiency, and growth, but they also expose companies to new layers of risk that can affect finances, reputation, and regulatory standing.

That is why third-party due diligence is essential. A structured due diligence program helps organizations identify and address legal, operational, and cybersecurity risks before they escalate. This guide outlines the key elements of third-party due diligence, best practices for implementation, and how Shared Assessments can help strengthen your approach to effective Third-Party Risk Management (TPRM).

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What is Third-Party Due Diligence?

Third-party due diligence is the process of evaluating external vendors, partners, or suppliers to assess potential risks before and during a business relationship.

Organizations perform third-party due diligence to meet regulatory expectations, manage reputational exposure, and safeguard data. Regulations such as the General Data Protection Regulation (GDPR), California Consumer Privacy Act (CCPA), and Anti-Money Laundering (AML) laws require companies to know who they’re doing business with.

The Foreign Corrupt Practices Act (FCPA) adds another layer of scrutiny as data show that roughly 90% of FCPA enforcement actions involve third-party intermediaries such as agents or distributors (White & Case Global Survey). This highlights the importance of thoroughly vetting and continuously monitoring third-party relationships.

Beyond compliance, due diligence helps protect brand reputation and customer trust by identifying unethical practices early and ensuring vendors maintain strong cybersecurity standards. A structured due diligence program reduces financial losses, regulatory penalties, and operational disruptions.

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Understanding Third-Party Risks

Third-party risks refer to the potential threats and vulnerabilities that arise from a company’s relationships with external vendors, suppliers, and partners. These risks can significantly impact a company’s reputation, financial stability, and compliance with regulatory requirements. Understanding third-party risks is crucial for effective risk management and mitigation.

There are several types of third-party risks, including:

• Cybersecurity risks: The risk of a data breach or cyber attack through a third-party vendor or supplier. With increasing cyber threats, ensuring that third parties have robust cybersecurity measures is essential.
• Compliance risks: The risk of non-compliance with regulatory requirements, such as anti-money laundering (AML) and know-your-customer (KYC) regulations. Non-compliance can lead to severe penalties and legal issues.
• Operational risks: The risk of disruptions to business operations due to third-party failures or inefficiencies. This can affect the supply chain and overall business continuity.
• Reputational risks: The risk of damage to a company’s reputation due to third-party actions or behaviors. Negative publicity or unethical practices by third parties can tarnish a company’s image.

To manage third-party risks, companies should implement a robust due diligence process that includes:

• Conducting thorough background checks on third-party vendors and suppliers.
• Assessing the third party’s business relationships and potential conflicts of interest.
• Evaluating the third party’s compliance with regulatory requirements.
• Monitoring the third party’s cybersecurity practices and protocols.
• Establishing clear contractual obligations and expectations.

By understanding and addressing these risks, companies can protect their assets, maintain regulatory compliance, and safeguard their reputation.

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Key Objectives of Third-Party Due Diligence

The primary goals of third-party due diligence include:

• Protect company assets and reputation by avoiding relationships with unethical or financially unstable vendors.
• Ensure regulatory compliance across global and industry-specific standards.
• Reduce cybersecurity risks through ongoing evaluation of vendors’ security measures.

Failing to conduct proper due diligence can result in legal liabilities, financial losses, and regulatory penalties, making it an essential part of any risk management strategy.

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Key Components of an Effective Due Diligence Process

An effective third-party due diligence process begins with identifying and assessing prospective third parties before forming business relationships. It typically includes the following components:

Risk Assessment

Before engaging with a third party, organizations must determine the level of risk associated with the relationship. Companies can:

• Categorize vendors based on risk factors (e.g., financial stability, regulatory compliance, cybersecurity measures).
• Use risk matrices and frameworks to prioritize due diligence efforts based on risk exposure, including understanding a third party’s business relationships to assess potential conflicts of interest.
• Implement risk tiering as higher-risk vendors require deeper investigations and ongoing monitoring.

Background Checks and Continuous Monitoring

Conducting background checks ensures that vendors have a strong financial and legal standing. This includes:

• Financial health assessments to evaluate solvency and stability.
• Legal history reviews to identify any past litigations, sanctions, or compliance violations.
• Ongoing monitoring to detect emerging risks and ensure continued compliance.

Assessing Data Security and Privacy

With cyber threats on the rise, companies must ensure that third parties adhere to strict data security and privacy standards. A due diligence process should include:

• Evaluating vendors’ data encryption and access control policies.
• Ensuring compliance with GDPR, CCPA, NIST, ISO, HIPAA, or other relevant regulations and frameworks.
• Assessing incident response plans to determine how vendors handle cybersecurity threats.

Compliance with Regulatory Standards

Organizations operate under a variety of legal and regulatory obligations, and it’s essential that third parties meet the same standards. Key examples include:

• General Data Protection Regulation (GDPR): Protects personal data privacy in the European Union.
• California Consumer Privacy Act (CCPA): Safeguards consumer data in California.
• Anti-Money Laundering (AML) laws: Prevent financial crimes and fraudulent transactions.
• Industry standards and frameworks: Guidelines such as NIST and ISO help define best practices for cybersecurity, risk management, and operational resilience.

By incorporating these requirements into your due diligence process, you ensure that vendors and partners operate ethically, securely, and in compliance with applicable laws and standards to reduce legal, operational, and reputational risk.

 

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Building a Due Diligence Program

A due diligence program is a systematic process for evaluating and managing third-party risks. Building a due diligence program requires a structured approach that includes the following steps:

1. Define the scope of the program: Identify the types of third-party relationships that require due diligence. This includes vendors, suppliers, contractors, and other business partners.
2. Establish a risk-based approach: Assess the level of risk associated with each third-party relationship. Higher-risk third parties may require enhanced due diligence.
3. Develop a due diligence framework: Create a framework for evaluating third-party risks, including criteria for assessment and evaluation. This framework should be standardized to ensure consistency.
4. Conduct due diligence: Gather and analyze information about the third-party vendor or supplier. This includes financial reviews, compliance checks, and cybersecurity assessments.
5. Evaluate and mitigate risks: Assess the risks identified during the due diligence process and implement mitigation strategies. This may involve negotiating contract terms or requiring additional safeguards.
6. Monitor and review: Continuously monitor the third-party relationship and review the due diligence process to ensure its effectiveness. Regular audits and updates to the due diligence program are essential.

A due diligence program should also include the following components:

• A clear policy and procedure for due diligence.
• A risk assessment framework.
• A due diligence questionnaire or template.
• A process for evaluating and mitigating risks.
• A system for monitoring and reviewing third-party relationships.

 

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Best Practices for Conducting Third-Party Due Diligence

Building an effective due diligence program requires structure, collaboration, and ongoing attention. Key best practices include:

1. Standardize Your Framework
Use a consistent approach to assess every third-party relationship. This can include risk scoring, compliance checklists, and automated monitoring tools to ensure no critical steps are overlooked.

2. Leverage Technology
Automation can save time and improve accuracy. Real-time risk assessments, automated compliance checks, and continuous monitoring help reduce manual errors and administrative burden. Utilize tools like the Shared Assessments TPRM Product Suite to streamline these processes and improve overall risk visibility.

3. Collaborate Across Teams
Due diligence is most effective when multiple departments contribute their expertise. Legal, compliance, risk management, and IT/cybersecurity teams should all be involved in evaluating contracts, regulatory obligations, and data security practices.

4. Review and Update Regularly
Risk and regulatory landscapes evolve quickly. Regularly reassess vendors, update policies, and conduct audits to ensure your due diligence program remains effective and compliant.

Taking these steps ensures that your organization can identify potential risks early, protect sensitive data, and maintain compliance across the board.

 

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Overcoming Challenges in Due Diligence

Due diligence can be a challenging and time-consuming process, especially when dealing with complex third-party relationships. Some common challenges include:

• Limited resources: Insufficient resources, including time, budget, and personnel, can hinder the due diligence process. Companies may struggle to allocate the necessary resources to conduct thorough evaluations.
• Complexity: Complex third-party relationships can make it difficult to identify and mitigate risks. Multiple layers of subcontractors and global operations add to the complexity.
• Lack of transparency: Limited visibility into third-party operations and practices can make it challenging to conduct effective due diligence. Third parties may be reluctant to share detailed information.
• Regulatory requirements: Evolving regulatory requirements can create challenges for companies seeking to comply with due diligence obligations. Keeping up with changes in laws and regulations requires continuous effort.

To overcome these challenges, companies can consider the following strategies:

• Leveraging technology: Utilizing technology, such as automation tools and data analytics, to streamline the due diligence process. Technology can help manage large volumes of data and provide real-time insights.
• Outsourcing: Outsourcing due diligence to specialized third-party providers. External experts can offer additional resources and expertise.
• Collaboration: Collaborating with other stakeholders, including business owners and risk managers, to share knowledge and expertise. A collaborative approach ensures a comprehensive evaluation of third-party risks.
• Training and awareness: Providing training and awareness programs for employees on due diligence best practices. Educating employees on the importance of due diligence and how to conduct it effectively is crucial.

 

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Driving Trust in Third-Party Relationships

Shared Assessments is a trusted leader for Third-Party Risk Management (TPRM) tools and frameworks. Our member-driven community advances best practices and standards in a shifting third-party risk landscape, empowering practitioners to navigate their careers and build stronger TPRM programs. Shared Assessments tools and membership help organizations to:

• Streamline vendor evaluations
• Enhance regulatory compliance
• Improve risk visibility across supply chains

 

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Strengthen Your Third-Party Due Diligence with Shared Assessments

To enhance your third-party risk management strategy, explore Shared Assessments’ comprehensive tools and resources:

✅ Certified Third Party Risk Professional (CTPRP) – A certification boot camp for experienced TPRM roles involved in the development, implementation and management of TPRM programs.
✅ Certified Third Party Risk Assessor (CTPRA) – A certification boot camp for experienced TPRM risk assessor roles involved in the planning, scoping and evaluation of a third-party’s control environment.
✅ Standardized Information Gathering (SIG) Questionnaire – The SIG allows organizations to build, customize, analyze, and store vendor assessments for managing third-party risk.
✅ Vendor Risk Management Maturity Model (VRMMM) – The VRMMM evaluates third-party risk programs against a set of comprehensive best practices and industry benchmarks.
✅ Third Party Service Inherent Risk Rating (TPSIRR) – The TPSIRR helps firms understand the inherent amount and types of identified risk posed by prospective third-party engagements and their potential impacts.

Ready to take the next step in strengthening your third-party due diligence efforts? Get in touch!

 

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Frequently Asked Questions (FAQs) on Third-Party Due Diligence

What is the Due Diligence Process for Third Parties?

The due diligence process involves risk assessments, background checks, compliance verification, cybersecurity evaluations, and continuous monitoring.

When Should You Conduct Third-Party Due Diligence?

Due diligence should be conducted before entering a business relationship and periodically throughout the partnership to detect emerging risks.

What are the Red Flags for Third-Party Due Diligence?

Common red flags include financial instability, compliance violations, legal disputes, lack of cybersecurity measures, and poor data protection policies.

How to Do a Due Diligence Checklist?

A due diligence checklist should include risk assessments, financial reviews, compliance verification, security evaluations, and ongoing monitoring.

What are 3 Examples of Due Diligence?

1. Regulatory due diligence – Ensuring compliance with laws like GDPR.
2. Financial due diligence – Assessing a vendor’s financial stability.
3. Cybersecurity due diligence – Evaluating data protection practices.