DUE DILIGENCE

Prof. Aparna Kanchan

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 What is Due Diligence?
Implies an activity involving either the performance of an
investigation of a business or person, or the performance
of an act with a certain standard of care

Also used to mean a required legal obligation although the

term more commonly applies to a voluntary investigation

Examples:
Steps carried out by venture capitalists before and during
each investment phase of a start-up company
Precautionary steps taken by one company in deciding
whether to acquire another i.e. evaluating whether the buy
is good or bad.

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 What is Due Diligence?
Banking Industry - To act in a prudent manner in evaluating
credit applications.

Securities Market - Responsibility of underwriters to explain

the details of new securities to interested purchasers.

Legal Definition - A measure of prudence, activity, or

assiduity, as is properly to be expected from, and ordinarily
exercised by, a reasonable and prudent person under the
particular circumstances; not measured by any absolute
standard but depends on the relative facts of the special
case."

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 Activities of Due Diligence
Financial Statements:
Review and confirm the existence of assets, liabilities, and equity in the
balance sheet to determine the financial health of the company based on
the income statement.
Management and Operations review:
Determine quality and reliability of financial statements to gain a
sense of contingencies beyond the financial statements.
Legal Compliance Review:
Check the potential future legal problems stemming from the target's
past.
Document and Transaction review:
Ensure paperwork of the deal is in order and that the structure of the
transaction is appropriate.
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 Need for Due Diligence

Strengths and weaknesses of the business

Gives a fair value of the investment

Helps in identifying the apparent irregularities

Tool of ensuring that the prevailing system of checks
works

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 What does Due diligence involve?

Historical Financial Data

Current Financial Data
Forecasted Financial Information
Business Plans
Minutes of Directors Meetings and Management
Meetings
Audit Paper Work Files
Contracts with Suppliers, Customers and Staff
Confirmation/ Representations from Financiers,
Debtors, etc.

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 Transactions requiring Due Diligence
Mergers and Acquisitions:
Personnel

Financial Operations

Marketing

Property and Equipments

Business Operations

Strategic Alliances and partnerships

Joint Ventures and Collaborations

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 People Involved in Due Diligence
Financial

Legal

Operational

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 Parties interested in Due Diligence

Employees

Trade Unions

Shareholders

Creditors

Vendors

Customers

Government

Society
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 Steps in Due Diligence Process

Planning Data Collection Data Analysis Report

Phase Phase Phase Finalization Phase

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Planning Phase
Defining the
Scope Sustainability of Business

Financials
Deciding the
Focus Area Competition
Management Team and Organizational Culture
Finalizing the
Team Structure Potential Liabilities

Technology
Clear definition Existing market potential
of
Responsibilities Business to Business fit

Defining time
schedules Timely Finalizing
communication templates and
of information tools required

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 Due Diligence Reporting

Should reflect a fair and independent analysis &

evaluation of financial and commercial information

Should ensure collection, analysis and interpretation of

financial, commercial and tax information in detail

Should provide properly reviewed and analyzed financial

information to bidders and various stakeholders

Should also provide a feedback on auditing of the

special purpose accounts.
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 Types of Due Diligence

Financial Due Diligence:

involves evaluating a companys historical, current,
and prospective operating results as disclosed in its
historical, current and projected financial statements, tax
returns, and other information

Involves analysis of balance sheet, review from cash

to marketable securities, receivables, inventory, prepaid
expenses and other current assets, as well as the value of
fixed assets.
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 Analysis on the liability side includes accounts payable,
taxes, and debt obligations must be closely examined

Helps in getting a sense of future revenues

Evaluates the underlying assumptions used

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Legal Due Diligence:
Scrutiny of all, or specific parts, of the legal affairs of
the target company with a view of uncovering any
legal risks and provide the buyer with an extensive insight
into the companys legal matters

Improves the buyers bargaining position and

ensures that necessary precautions in relation to the
transaction are taken

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 Objectives of Legal Due Diligence

Gathering of information from the target company,

Uncovering of the target companys strong and weak
sides, relevant risks and advantages in connection with
the transaction,
Minimizing the risk of unexpected situations,
Improvement of the sellers bargaining position,
Identification of areas where representations and
warranties from the seller should be obtained in the
acquisition agreement.

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 Documents verified
Confidentiality and invention
IT law and IT contracts assignment agreements with
employees
Intellectual property rights
Tax and financial documents
Patents, copyrights, and other
intellectual property- related Legal disputes and other kinds
documents of conflicts
Company law Marketing practices regulation
Financing National and EU-competition
law
Employment law
Public procurement law.
Data protection law
Consumer protection law
General contract law
Minutes and consents of the
board of directors and
shareholders 17
Operational Due Diligence:
Involves the on-site analyses of the target business
daily processes and of how the business operates.
Analysis includes an evaluation of the key employees,
managers, independent contractors, suppliers and
other factors necessary for the business to conduct
normal operations

May also cover investigation outside of the actual

business. 18
 Includes examining work centres, material flow, scrap
generation, and inventory levels to identify
improvements required to improve productivity and
profitability
Helps identify and implement changes necessary to
increase EBITDA and increasing the multiples due to
lower risk.
Involves gathering information on:
New product or service creation
Markets
Competition
Sales Targets
People/Organizational matters
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 Intellectual Property Due Diligence
Through analysis needed in this area as economies
are increasingly becoming technology driven
process of identifying all intellectual property assets,
verifying ownership and ensuring that such assets are
free of encumbrances for the intended business use is
fundamental to any merger, acquisition or investment

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 Examples range from the ingredients and manufacturing
process for coke, a closely guarded
trade secret, to the many domestic and international
trademarks owned by multinational conglomerates such
as Tata, HUL, Reliance, etc.

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 IT Due Diligence;
Involves scrutiny of IT systems and processes in use
and ascertaining better ways of deriving value
and leverage from IT assets

Involves:
Sending an IT request list to the acquired company
Compiling an onsite discovery process outline
Conducting a review of the requested materials
Scheduling and coordinating the onsite visit

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 Human Resource Due Diligence:
Involves valuing the contribution of HR
Helps by:
Establishing a link between organizational objectives and the HR function
Determining HR's influence on the skills and motivation of the workforce
Determining the managers views of the HR function
Ascertaining the outcomes produced by the HR deliverables
Measuring the adequacy of HR measures, metrics and benchmarks
Ascertaining the total cost of the HR function and industry comparisons
Ascertaining the HR team structure, skills and motivation.

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 Areas covered

Organizational culture
Executive compensation and golden parachute
contracts
Collective bargaining agreements and potential change
of ownership liabilities
Defined benefit and contribution pension plans
Postretirement benefits
Retention and severance plans
Health and welfare insurance structure and reserves
HR functional structure and service delivery
HR Information System (HRIS) and
Employment Litigation 24
 Does Due Diligence insure against M & A
failure?
Helps avoid:

unnecessary losses and expenses

The organizations governing body is able to demonstrate that it

has engaged in effective oversight and

Senior officers of the company avoid job- and bonus-

threatening adverse events

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 Effective Due Diligence team

Have members with first hand experience in the industry to

which the target belongs
Have members with expertise in different areas such as HR
specialists, Functional area managers, individuals with
knowledge of national culture, etc. Capable of quickly
identifying both the positive and negative aspects of the
property to be acquired.
Willing to carry out a site visit to evaluate the current
condition of the assets to be acquired; both the physical
assets as well as the personnel
Have members who possess excellent negotiation skills
Have people who have time to lead the project and serve as
team members
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 Ensure that the diligence team is co-located within a secure
environment, such as a corporate headquarters or closer to the
target
Be familiar with the strategic and financial rationale behind the
acquisition
Train the team to identify and home in on specific issues

Develop and communicate rules of engagement between

the diligence team and the target company
Make available analytical tools and techniques so the team can
rapidly get its arms around potential synergies and integration
challenges
Healthy flow of information

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 Why Due Diligence fails?

Failure to Focus on Key Issues

Failure to Identify New Opportunities and Risks

Failure to Allocate Adequate/ Right Resources

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THANK - YOU

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