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Author - Associate Swetha Logachandru

Due diligence is done before business transactions, and it is an indispensable process in cases such as business mergers, amalgamations, acquisitions, investments, etc. These are the cases where an in-depth investigation and analysis is made into the business, financial, accounting, legal and other relevant aspects of the target company. It embodies honest disclosure by the target company and diligent investigation and SWOT analysis by the acquirer company. Due diligence is done to avoid fraudulent and detrimental business activities; moreover, the Due Diligence Report can effectively function as a bargaining chip in a business transaction.

There are mainly two ways in which information and documents are exchanged:

• In a Data Room, which is a physical or virtual data repository where all the relevant and necessary information are kept and presented to the prospective buyers, after signing the Non-Disclosure Agreement, or
• The relevant information is provided to the buyer on receiving the checklist

After signing the Letter of Intent, the sensitive and confidential data is shared with the buyer only after negotiating the Terms of Engagement and signing a Non-Disclosure Agreement.

The Due Diligence process differs based on the business sector and the nature and needs of the business transaction. The essential factors to be checked are enumerated in this article.

Due Diligence takes place in three stages:

1. PRE DILIGENCE:

The Letter Of Intent, Non-Disclosure Agreement and the Terms of Engagement are negotiated and signed. The necessary documents are organized, a Data Room is created, and any checklist for documents to be given to the Target Company is given at this stage. The corporate documents of the Target Company can be sought from the Ministry of Corporate Affairs for verification. It is advised that the Acquirer prepares an exhaustive checklist for verification or audit, and not just rely on the data provided by the Target Company. As fraud and misrepresentation are always a possibility, every relevant aspect of the company should be thoroughly investigated and verified.

2. DILIGENCE:

The information and documents presented by the Target Company are verified and cross-checked by the Acquirer. Based on the nature and objective of the transaction, various types of Due Diligence are incorporated in the investigation. This is done by professionals like Chartered Accountants, Attorneys, IT Professionals, etc. A report is prepared and shared with both the Target and Acquirer Companies.

The investigation covers the following areas but is not exhaustive of the list given below:

• Legal compliances
• corporate governance and policies
• Past violations and penalties
• Lawsuits, litigations, etc
• Assets and liabilities
• Intellectual property and Human Resource
• Financial statements, corporate structure, funding, business model
• Tax compliance and allied issues, IT security and risks
• Goodwill, brand value and image, customer relations and base, public image, cultural and ethical sensitivity and other intangible assets.
• Operational efficiency, weakness and control
• Organizational and business strategy
• Contingencies and risks involved
• Risk management system
• Technology and Research and Development
• Business failures, profits, revenue and credentials
• Profile and credentials of the directors, investors, shareholders, mercantile bankers and other personnel
• In the case of MNC, cross border issues like investment climate, double taxation, FDI policies, etc.

BUSINESS DUE DILIGENCE:

The operational, technical, strategic, environmental, human resource policies and talent pool, employee relations and benefits, administrative structure and efficiency, information security and technological prowess, research and development, corporate culture and ethical aspects of the target company are thoroughly investigated. The overall feasibility of the transaction and desirability of the target company are assessed. Intellectual property like trademarks, patents, copyrights, pending patents; the reputation and character of the company, effective PR management team, goodwill and sometimes, the Diversity and Inclusiveness policy of the company are assessed.

FINANCIAL DUE DILIGENCE:

It is the most critical task in due diligence as this is the part where high-risk fraudulent misrepresentations can happen. The book of accounts, financial statements, cash flow information, transparency, tax compliance and liabilities, accounting policies, internal audits, etc. are carefully scrutinized. All the accounting and financial records of the target company are to be cross-checked by the acquirer to verify that they have abstained from creative accounting.

LEGAL DUE DILIGENCE:

The corporate documents of the company, the compliance of various legislations and government regulations like the Companies Act, SEBI, etc, the past and impending lawsuits, liabilities, the legal risks for the acquirer, etc are assessed.

3. POST DILIGENCE:

The Due Diligence Report is used as a bargaining chip, like any non- compliance, lawsuits, etc would prove detrimental to the valuation of the Target Company whereas the goodwill, proper compliances, patents, etc would increase the valuation and negotiating the position of the Target Company. The report should contain only the essentials and should be properly structured with no errors. Non-compliances are addressed and any negotiations, changes or corrections in the valuation are made.

BIBLIOGRAPHY

• The Institute of Company Secretaries of India study material for Professional Programme- Secretarial Audit, Compliance Management and Due Diligence

WEBLIOGRAPHY

1. Checklist for Due Diligence of Company. (2018, April 12). Retrieved from https://www.indiafilings.com/learn/checklist-for-due-diligence-of-company/
2. M&A Due Diligence Checklist. (n.d.). Retrieved from https://www.priorilegal.com/deals/mergers-acquisitions/manda-due-diligence-checklist
3. How can I plan for the due diligence process? (n.d.). Retrieved from https://legal.thomsonreuters.com/en/insights/learn/how-can-i-plan-due-diligence-process?amp
4. Chen, J. (2019, May 17). How Investors can Perform Due Diligence on a Company. Retrieved from https://www.investopedia.com/terms/d/duediligence.asp
5. Pandey, A. (2017, September 4). Due diligence in India - what every entrepreneur needs to know. Retrieved from https://blog.ipleaders.in/due-diligence-india-every-entrepreneur-needs-know/