Due Diligence In Corporate Governance

DUE DILIGENCE

Due Diligence is a 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 before any M&A transactions, etc.

India presents a sophisticated economic, regulatory, and legal landscape for doing business. Hence, business venture success in India is dependent on a company’s ability to pass over the Indian business landscape. A company’s success is in turn linked to the risk management and easing strategy that it undertakes. It is in this regard that due diligence becomes a powerful tool that companies may utilize when dealing with Indian businesses. Due diligence ensures that a company is able to manage the risk prior to entering into a business transaction.

Purpose of Due Diligence

Due diligence is primarily a way to reduce risk exposure. The process ensures that a party is aware of all the details of a transaction before they agree to it. For example, a broker-dealer will give an investor the results of a due diligence report so that the investor is fully informed and cannot hold the broker-dealer responsible for any losses.
Due diligence essentially performs a Strengths­ Weaknesses-Opportunities- Threats (SWOT) analysis of possible business opportunities. It involves the comprehensive assessment of a business opportunity undertaken by interested parties in the business, including prospective buyers and partners. The activity requires an assessment of all relevant business information, such as assets and liabilities in the company’s past and present, and evaluate the financials of the business.

Reasons to conduct Due diligence

Companies conduct Due diligence for several reasons:

  • To authenticate & verify information that was brought up during the deal or investment process
  • To identify potential threat and defect in the deal or investment opportunity and thus avoid a deficient business transaction
  • To procure relevant information regarding company that would be useful in valuing the deal
  • To validate that the deal or investment opportunity is acting accordance to the investment or deal criteria

Tools of due diligence

Evaluating the importance of Due Diligence, the next question that comes to mind is how to go about it and what are the tools for performing due diligence. Due to having complex nature of commercial transactions both local and international no single systematic method can be prescribed as such.

One of the ways to ascertain about it is to put a questionnaire to target company to check about its general and financial health, risks involved in the business of the company.

Another way is the representations and warranties that the seller can be asked to make in the commercial contract.

The third method is to review, in an integrated manner, the financial analysis of the seller’s business with the analysis of the legal risks that are associated with the transaction.

Below are the some of the Due Diligence and Questions to Ask the Seller in M&A Transaction Before Starting the DD Process:

Question-related to the target company: 
· Who are the security holders?
· Who are the key players in the organization?
· Who are the board members and stakeholders?
· Why does the company want to be merged?
· What are the business plans of the company?
· What is the corporate structure of the company?
 
Question-related to financial matters of the company:
· What are the operating costs?
· What are the accounting policies of a company?
· Does the company have any debts?
· What are the company’s major growth drivers?

Question-related to the employee and labor:
· What benefit plans are the company is providing to the employees?
· What is the headcount of the employees in each location?
· Is there any employee handbook or manual?
· How does the company evaluate and survey the employee’s performance?

Question-related to the legal issues?
· Are there any threatened litigations against the company?
·  Are there any settled litigations against the company?
· Are there any regulatory proceedings against the company?
· Does all the licenses and permits of the company are approved?

Question-related to Intellectual Property (IP):
· What trademarks and patents does the company currently have?
· What websites and domains does the company currently own?
· What is the company’s process for developing the IP?
· Does the company have any IP owned by the third party?
· Does the company currently engaged in developing any new IP?

Question-related to the Company’s Consumers?
· Who are the top consumers of the company over the last 3 years?. How did the company acquire them?
· What do the consumer’s contracts consist of?
· Which consumers have been lost over the last 2 fiscal years? What are the reasons?

Question-related to the products of the company?
· What are specific products and services does the company offer?
· Who are the company’s suppliers?

Steps involved in the due diligence process

Due diligence in M&A is a lengthy process that involves multiple parties and phases. General due diligence process steps are given below.

1. Evaluate Project’s Goal:

As with any project, the first step is to describe corporate goals. This helps to spot resources required, what you need to obtain, and ultimately assure the overall positioning with the firm’s overarching strategy.

This involves introspective questions revolving around what you need to gain from this investigation.

2. Business Financials Analysis:

This step is a comprehensive audit of financial records. It ensures that documents portrayed in the Confidentiality Information Memorandum (CIM) were not fumbled.

Additionally, it helps measure the company’s asset health, overall financial performance, and stability, and detect any loopholes.

Some of the Items inspected here include:

  • Balance sheets and income statements
  • Inventory schedules
  • Future forecasts and projections
  • Revenue, profit, and growth trends
  • Stock history and options
  • Short and long-term debts
  • Tax forms and documents
  • Valuation multiples and ratios in comparison to competitors and industry benchmarks

3. Thorough Inspection of Documents

This due diligence step begins as a two-way conversation between buyer and seller. The buyer asks for respective documents to audit, conducts interviews or surveys with the seller, and goes on on-site visits.

Responsiveness and organization on the seller’s end are key to expediting this process. Otherwise, it may create a hard experience for the buyer.

Following, the buyer examines the information collected to ensure proper business practices as well as legal and environmental compliances. This is the major part of the due diligence process.

Overall, the buyer gains a better understanding of the firm as a whole and can better appraise long-term value.

4. Analysis of Business Plan and Model:

In this, the buyer looks specifically at the target company’s business plans and model. This is to evaluate whether it is feasible and how well the firm’s model would integrate with theirs.

5. Final Offering Formation

After information and documents are gathered and examined, individuals and teams collaborate to share and evaluate their findings.

Analysts utilize information collected to perform valuation techniques and methods. This supports the final dollar you are willing to offer during negotiation.

6. Risk Management

Risk management is done to look at the target company holistically and forecast risks that may be associated with the transaction.

Therefore, due diligence is the key and foremost important process to start any corporate transaction it helps in the evaluation of the health of the target company and brings out the understanding between the parties of the parties of the corporate transaction.

Reference:

https://www.coursehero.com/file/p5lub5f9/4-What-are-the-independence-requirements-for-firms-and-assurance-teams/

https://www.mondaq.com/india/operational-performance-management/17241/legal-due-diligence#:~:text=Tools%20of%20due%20diligence

https://www.mondaq.com/india/operational-performance-management/17241/legal-due-diligence

Due Diligence

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