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Due Diligence

M&A

Prof.Sonali

3/28/2012

Operational Due Diligence


Operational Due Diligence (ODD) enhances decision

making and reduces risk through a better understanding of how the business works. It provides a more robust perspective on what a client can expect from the target's future operational performance. One measure the effectiveness and efficiency of the company's business units against the management's own performance targets, as well as industry benchmarks. One also have to identify the developments within the industry that can impact the operational efficiencies of the target, and wherever possible, develop mitigation plans.
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Operational Due diligence varies from target to target .It involves gathering information about : New product or service creation

Process of New Product Development ,R & D Markets Targets Customers ,Market share, Factors affecting demand in the targets market ,Segmentation, Seasonality Competition Market Share of the competitors Sales Information on Targets Sales forces' salary, compensation pattern etc People/Organizational matters Number of employees ,their functions ,trained or untrained workforce
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Financial Due Diligence


Analyses the financial performance of an entity. Involves in-depth analysis of the balance sheet ,cash,

marketable securities ,receivables, inventory ,prepaid expenses and other Fixed ,Current assets . On the liability side the analysis covers accounts payable ,taxes and debt obligations are closely examined Also analyses contingent liabilities

M&A

Prof.Sonali

3/28/2012

Financial statements commonly consist of the following items: Income statement Balance sheet Cash flow statement Notes to the financial statements Key performance indicators (KPIs) based on financial statements and their development over time, provide good measures for the reasons behind positive or negative performance of a business: Gross margin Operating margin Working capital days Debt Equity ratio

M&A

Prof.Sonali

3/28/2012

Financial statements are typically the basis for determining

valuation Identify inconsistent accounting policies Understand the estimates and judgments used in reported numbers Identify matters that impact valuation To advise on the level of EBITDA/EBIT

M&A

Prof.Sonali

3/28/2012

Sales by region/ customer/ product Volumes Prices Cost of sales Raw

materials (such as volumes, prices, supplier dependency) Manufacturing costs (costs per unit) Margins by region/ customer/ product Overhead costs - Fixed Vs Variable EBITDA/EBIT development over a number of period
Prof.Sonali 3/28/2012

M&A

Inventory valuation Debtors ageing and provisioning Nature of long and short term advances Liabilities Payment terms Provisioning policy Fixed assets Degree of depreciation Capital expenditure Working capital items impact purchase consideration Cash flow impacts Seasonality

price

M&A

Prof.Sonali

3/28/2012

Key issues in FDD


Revenue drivers and recognition issues Cost drivers and accrual issues Depreciation policies adopted Valuation of current assets Adequacy of accruals Advance Tax / Provision for Taxation Contingent liabilities and off balance sheet items

M&A

Prof.Sonali

3/28/2012

FDDs Relation with Other DDs


Framework of Due Diligence is designed for Client Success Commercial due diligence compares future business plan and

revenue potential with the industry trends Cost assumptions may be tested through technical and Operational due diligence Various costs impact profitability e.g. employee related matters could be tested through HR due diligence Legal due diligence helps in spotting various hidden issues like arrangements with associates and stakeholders Financial Due Diligence overlaps with all other areas of Due Diligence and should not be conducted in isolation

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M&A

Prof.Sonali

3/28/2012

Legal Due Diligence


Consists of 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

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M&A

Prof.Sonali

3/28/2012

Documents/Areas to be verified
IT law and IT contracts IP rights Patents ,copyrights and other IP related documents Company law Finance Employment law Data Protection law

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M&A

Prof.Sonali

3/28/2012

Documents/Areas to be verified
Consumer Protection law General contract law Minutes and consents of the board of directors and

shareholders Confidentiality and invention assignments and agreements with employees Tax and Financial documents Legal disputes and other kind o f conflicts National and EU competition laws Marketing practices regulation
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HR Due Diligence
It is a process that aims at assessing the contribution of HR

function to the success of the business in a purchasing, outsourcing or market testing environment

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M&A

Prof.Sonali

3/28/2012

HR Diligence helps in following ways


Establishing a link between organizational objectives and

the HR function Determining HRs influence on the skills and motivation of the workforce Determining managers views of the HR function Measuring the adequacy of HR measures ,metrics and benchmarks Ascertaining total cost of HR function and industry comparisons Ascertaining the HR team structure ,skills and motivation

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M&A

Prof.Sonali

3/28/2012

HR Due Diligence aims at seeking answers to the following issues : Analyzing HR structure and policies in the target company Ascertaining whether the target company possess human

resources to support the products, technology, markets or goodwill Evolving an action plan to retain key individuals after the merger Evolving a strategy action plan to integrate the target companys HR processes and culture with the buyer company quickly and smoothly to minimize uncertainties among employees and demonstrate value to the customers

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M&A

Prof.Sonali

3/28/2012

HR Due Diligence aims at seeking answers to the following issues : Evolving the right approach information to make staffing

and organizational decisions quickly to avoid unnecessary anxiety ,destructive rumours and unwanted departures
Visualize

the skills, experience ,knowledge ,specific industry experience and contacts that may be lost post merger ,determine the impact of these potential losses and designing coaching ,employee development or recruiting plans to replace key competencies .

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M&A

Prof.Sonali

3/28/2012

IT Due Diligence
There are four steps to due diligence preparation 1. Sending an IT request list to the acquired company 2. Compiling an onsite discovery process outline 3. Conducting a review of the requested materials 4. Scheduling and coordinating the onsite visit The primary objective of the IT due diligence effort is to maximize the opportunity to discover relevant issues surrounding the companys technology and accordingly initiate corrective measures
M&A Prof.Sonali

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3/28/2012

IP Due Diligence

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M&A

Prof.Sonali

3/28/2012

Introduction: What is IP?


Most creations resulting from human endeavors in various fields of art, literature ,science and technology constitute Intellectual Property
Ownership Valuable Assets Intangibles

Special Rights

Intellectual Property

Time & cost intensive

Transferable
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Additional Profits

Trademark & domain names

Copyright

Trade secrets

Patent

Categories of IP rights
Utility model/Designs Geographical Indications

Plant Breeders rights

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Different Acts governing IP assets


Trade Marks The Trade Marks Act, 1999 The Patents Act, 1970 The Copyright Act, 1957 The Designs Act, 2000 The Geographical Indications Of Goods Act, 1999 The Protection of plant varieties and Farmers Right Act, 2001 Semi conductor IC layout design Act,2000

Patents
Copyright

Designs
Geographical Indications Plant Varieties Semi conductor IC layout

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IP due diligence in Mergers & Acquisitions


IP Due diligence is the process of investigating a partys

ownership, right to use, and right to stop others from using the IP rights involved in sale or merger ---the nature of transaction and the rights being acquired will determine the extent and focus of the due diligence review.

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Seth Associates, 2006 All Rights Reserved

Due-diligence should reveal


Who owns the rights? Are the rights valid and transferable and enforceable? Are there any agreement or restriction that prevent the party

for granting rights to other? Is the property registered in the proper office? Any shortcoming or default on payment? Any past or potential litigation? Has the property being misused in the past rendering right unenforceable? It should also evaluate agreements material to the companys business that may be affected by change of control, agreements that may vest rights in intangibles, and company policies and practices.
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Due Diligence Team


Key requirement in evaluating a possible M & A is a strong

due diligence team capable of carrying out a quick and effective review of the assets after the confidentiality agreement has been attained . Composition of an effective due diligence team will vary greatly depending on the asset to be reviewed . If the team lacks the right persons, the very purpose of due diligence stands defeated .

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M&A

Prof.Sonali

3/28/2012

The team members should have following attributes


Must have first hand experience in the industry to which

the target belongs The team should have experts from different areas such as HR specialist ,functional area managers ,individuals with knowledge of the national and organizational culture etc .Such expertise is valuable and helps the team attain the buy-in from line management which can be hard to get if a key functional area is shut out of the integration process Team should be capable of quickly identifying the positive and negative aspects of the property to be acquired

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M&A

Prof.Sonali

3/28/2012

Members should be willing to carry out a site visit to evaluate

the current condition of the assets to be acquired both physical assets as well as the personnel Should possess excellent negotiation skills Should have time to lead the project and serve as team members Team should be co-located within a secure environment such as corporate headquarters

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M&A

Prof.Sonali

3/28/2012

Team should be familiar with strategic and financial rationale

behind the acquisition Should be trained to identify and zero in on specific issues including the analysis and data required Care should be taken to develop and communicate rules of engagement between the diligence team and the target company .This avoids cultural conflicts and ensures that the team acts in a manner that reflects the acquirers intentions The team should get analytical tools and techniques so that it can rapidly get its arm around potential synergies and integration challenges This helps the team complete its task within the allotted time and budget

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M&A

Prof.Sonali

3/28/2012

There must be a healthy flow of information from the due

diligence team to the integration team . Therefore include due diligence team members in the integration planning team to ensure that diligence rationale and data analysis are properly leveraged

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M&A

Prof.Sonali

3/28/2012

Why does due diligence fail ?


It is a challenging task Quite often the team handling it goes off track giving

disastrous results

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M&A

Prof.Sonali

3/28/2012

Three themes of Failure


Failure to focus on key issues Failure to identify new Opportunities and Risks Failure to Allocate Adequate /Right Resources

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M&A

Prof.Sonali

3/28/2012

Failure to focus on key issues


Irrelevant data collection New Method of Analysis

,instead use tested diligence methodology ,standardized formats and simple software Team reluctant to share information among team members Sharing resources helps in quickly identifying deal killers

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M&A

Prof.Sonali

3/28/2012

Failure to identify new Opportunities and Risks


The

team should test the key assumption of the management before proceeding with the task ,helps in remaining focused . Should probe deeply into the merits of the deal to identify the value drivers and key risks . Dont rely solely on information provided by the target company; collect information from other sources customers, vendors ,employees

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M&A

Prof.Sonali

3/28/2012

Failure to Allocate Adequate /Right Resources


Put the best people on the team ; right expertise ,functional

areas that would be affected by the deal Dont set arbitrary deadlines ;time needed to research review and report Provide adequate resources such as space to work ,equipment, software ,staff and access to the right data and people. Relieve them of their daily responsibilities so they can focus on the task at hand

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M&A

Prof.Sonali

3/28/2012

References
Mergers and Acquisitions Rajinder Arora ; Oxford

publication

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M&A

Prof.Sonali

3/28/2012