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Due Diligence

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.

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."

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. Determine quality and reliability of financial statements to gain a sense of contingencies beyond the financial statements. Check the potential future legal problems stemming from the target's past. Ensure paperwork of the deal is in order and that the structure of the transaction is appropriate.

Management and Operations review:

Legal Compliance Review:

Document and Transaction review:

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

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.

Transactions requiring Due Diligence

Mergers and Acquisitions:


Personnel Financial Operations Marketing Property and Equipments Business Operations

Strategic Alliances and partnerships Joint Ventures and Collaborations

People Involved in Due Diligence

Financial

Legal

Operational

Parties interested in Due Diligence


Employees Trade Unions Shareholders

Creditors
Vendors Customers Government Society

Steps in Due Diligence Process

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.

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.

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

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

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.

Documents verified

IT law and IT contracts Intellectual property rights Patents, copyrights, and other intellectual property-related documents Company law Financing Employment law Data protection law Consumer protection law General contract law Minutes and consents of the board of directors and shareholders

Confidentiality and invention assignment agreements with employees Tax and financial documents Legal disputes and other kinds of conflicts Marketing practices regulation National and EU-competition law Public procurement law.

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.

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

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

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.

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

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.

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

Litigation Analysis
When one company sells or otherwise transfers all its assets to another company, the successor is not liable for the debts and tort liabilities of the predecessor. Successor may be liable, however, under the following circumstances:

If it has expressly or implicitly agreed to assume liability


If the transaction is a merger or consolidation

If the successor is a mere continuation of the predecessor


If the transaction was fraudulently designed to escape liability.

Components of Litigation Analysis


Customers -- as well as competitors, suppliers, and other contractorsmight sue over: contract disputes cost/quality/safety of product or service debt collection, including foreclosure deceptive trade practices dishonesty/fraud extension/refusal of credit lender liability other customer/client issues restraint of trade

Employees -- including current, past, or prospective employees or unionsmight sue over: breach of employment contract defamation discrimination employment conditions harassment/humiliation pension, welfare, or other employee benefits wrongful termination

Regulators might sue over:

antitrust (in suits brought by government)

environmental law
health and safety law

Shareholders might sue over:


Contract disputes (with shareholders) Divestitures or spin-offs Financial transactions (such as derivatives) Fraudulent conveyance Investment or loan decisions M&A scenarios (target, bidder)

Dividend declaration or Change duties to minority shareholders


Executive compensation (such as golden parachutes) Financial performance/ bankruptcy

General breach of fiduciary duty


Inadequate disclosure

Proxy contents

Recapitalization

Insider trading

Share repurchase Stock offerings

Suppliers might sue over:


antitrust (in suits brought by suppliers) business interference contract disputes copyright/patent infringement deceptive trade practices

Does Due Diligence insure against M & A failure?

Helps avoid:

Able to 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

Due Diligence involving Financial Issues

Can lead to significant unbudgeted liabilities and the diversion of time and energy of key executives Helps identify fictitious bills and fictitious originals created such as the signature-authority list. Helps identify dormant bank accounts for they are a breeding ground for manipulative practices. Unexpected voiding of invoices from the organizations accounts receivable system should be investigated, particularly if your organization is structured so that people who have the ability to void an invoice also have the ability to receive or issue cheques

Due Diligence Involving Organizational Records

Periodic review of the minutes of board meetings needs to be done.

Record retention policies are often advocated across countries as a reliable tool of reference.

Due Diligence involving Legal Compliance

Helps ensure that the organization is in compliance with applicable law Depending on the nature and size of an organization, professional advisors should be engaged to evaluate the laws and regulations as applicable, and to help management design a due diligence plan Compliance can be achieved in an orderly, cost-effective and timely manner

Due Diligence involving Interaction of Contracts

Involves due diligence of key contracts and agreements, and summarizing and cross-referencing
Critical for future reference Help in avoiding inadvertent conflicts.

Due Diligence involving Information Systems

Helps to get tuned to the rapid shift from manual system infrastructure to technology driven infrastructure. Ensures adherence to regulatory compliance that are coming into force.

Due Diligence involving Key Customers and Suppliers

Strong need to initiate ongoing monitoring of the operations and plans of key customers and suppliers as can reveal important information on its current financial and operational status and near-term future events. Also reveal a deteriorating financial condition in advance.

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

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

Why Due Diligence fails?

Failure to Focus on Key Issues

Failure to Identify New Opportunities and Risks

Failure to Allocate Adequate/ Right Resources

Thank you!