Merger and Acquisitions DUE DILIGENCE- Objective and Types

Due Diligence is the process by which confidential legal, financial and other material information is exchanged, reviewed and appraised by the parties to a business transaction, which is done prior to the transaction.  Due diligence is the process of disclosure and review of the seller’s business, which often includes its financial statements, corporate and organizational records, contracts, real and personal property, intellectual property, litigation, permits and authorization, and employment policies and benefits.

The scope of the due diligence process varies among transaction and depends on the industry and complexity of the business, financial resources and risk tolerance of the buyer and timing of the transaction.

Due diligence is used to investigate and evaluate a business opportunity. The term due diligence describes a general duty to exercise care in any transaction. As such, it spans investigation into all relevant aspects of the past, present, and predictable future of the business of a target company.

Due diligence is an investigative process for providing, the desired comfort level
about the potential investment and to minimize the risks such as hidden uncovered liabilities, poor growth prospects, price claimed for proposed investment being on higher side etc. Due diligence is also necessary to ensure that there are no onerous contracts or other agreements that could affect the acquirer’s return on investment.

The procedures and analyses ultimately represent a window into the target Company’s success and potential, including what opportunities exist to grow the business further to meet your goals and objectives.

The objective of due diligence is to verify the strategic identification or attractiveness
of the target company, valuation, risk associated etc.

The objective of due diligence includes—

1. Collect material of information from the target company.

2. Conduct a SWOT analysis to identify the strength and to uncover threats and weaknesses.

3. For improving the bargaining position depending on SWOT analysis.

4. To take an informed decision about an investment.

5. Identification of areas where representations and warranties are required.

6. To provide a desired comfort level in a transaction.

7. To ensure complete and accurate disclosure.

8. Bridge the gap between the existing and expected.

9. To take smooth/accurate action/decision.

10. To enhance the confidence of stake holders.

1. Business Due Diligence

2. Legal Due Diligence

3. Financial Diligence

1. Business Due Diligence

Business due diligence involves looking at quality of parties to a transaction, business prospects and quality of investment. It involves,

(i) Operational due diligence

Operational due diligence aims at the assessment of the functional operations of the target company, connectivity between operations, technological upgradation in operational process, financial
impact on operational efficiency etc. It also uncovers aspects on operational weakness, inadequacy of control mechanisms etc.

(ii) Strategicvdue diligence

Strategic due diligence tests the strategic rationale behind a proposed transaction and analyses whether the deal is commercially viable, whether the targeted value would be realized. It
considers factors such as value creation opportunities, competitive position, and critical capabilities.

(iii) Environmental Due Diligence

Environmental due diligence analyses environmental risks and liabilities associated with an organization. This investigation is usually undertaken before a merger, acquisition,
management buy-out, corporate restructure etc. Environmental due diligence provides the acquirer with a detailed assessment of the historic, current and potential future environmental risks associated with the target organization’s sites and operations.

(iv) Human Resource Due Diligence

Human Resource Due Diligence aims at people or related issues. Key managers and scarce talent leave unexpectedly. Valuable operating synergies gets disturbed, when cultural differences between
companies aren’t understood or are simply ignored. It’s crucial to consider cultural and employees issues upfront, for success of any venture.

(v) Information Security Due Diligence

Information security due diligence is often undertaken during the information technology procurement process to ensure that risks are uncovered.

(vi) Ethical Due Diligence

Ethical Due Diligence measures ethical character of the company and identify the possibilities of ethical risks, which is a non-financial risk. It may relate to reputation, governance, ethical values etc. It helps an organization to decide whether the partner is ethically viable. This is an effective reputation management tool for any type of business decisions.

B. Legal Due Diligence

A legal due diligence covers the legal aspects of a business transaction, liabilities of the target company, potential legal pitfalls and other related issues. Legal due diligence covers intra-corporate and inter-corporate transactions. It includes preparation of regulatory checklists meeting with personnel, independent check with regulatory authorities etc. apart from document verification.

C. Financial Due Diligence

Financial due diligence provides peace of mind to both corporate and financial buyers, by analyzing and validating all the financial, commercial, operational and strategic assumptions being made.

Financial Due Diligence includes review of accounting policies, review of internal audit procedures, quality and sustainability of earnings and cash flow, condition and value of assets, potential liabilities, tax implications of deal structures, examination of information systems to establish the reliability of financial information, internal control systems etc.

Also Read: Vertical Restraints in Digital Economy

The tax due diligence comprises
an analysis of:

— tax compliance

— tax contingencies and
aggressive positions

— transfer pricing

— identification of risk areas

— tax planning and opportunities

Due Diligence is the process by which confidential legal, financial and other material information is exchanged, reviewed and appraised by the parties to a business transaction, which is done prior to the transaction. The nature and scope of Due Diligence vary from transaction to transaction.

 The aspects such as Creation of data room, execution of non-disclosure agreement are very important to carry out due diligence exercise. The data room may be virtual or physical. Due Diligence may be business, operational strategic, human resource, ethical, cultural, legal,
secretarial etc. Certain transactions like Mergers, Acquisitions, Venture Capital Investment, Initial Public Offer etc require Due diligence exercise. Due diligence is different from audit. Audit is the inancial post mortem analysis. Due diligence analyses past, present and future issues (both financial and non financial).

Bibliography

1. Secretarial Audit, Compliance Management and Due Diligence- ICSI

2. Mergers and Acquisitions –A.P. Dash