Everyone wants to expand their business either by way of merging or buying different companies. But wait; have you checked all the prospective carefully? Sadly, I have come across various examples where the companies step back after 1 to 2 years of acquisition all because of lack of due diligence.
Due diligence is not a new concept and is in action from the last fifteenth century. However, it was legally introduced in the late 1930s. Various entities such as banks, private companies, etc. perform it to review multiple aspects of the other company before making a final decision.
Now you might be thinking why it so important. Don’t worry because today’s article will provide you all the required information regarding due diligence, its importance, and its purpose.
What is Due Diligence?
The verbal meaning of due diligence in research and investigation while diligent means to be hardworking, attentive, and thorough. Due diligence is a necessary process that involves proper research and analytic evaluation before investing in a company, acquisition of a company, staring a business partnership, or while providing a bank loan. It is done with a motive to determine the actual value of the proposed company and to evaluate any type of significant issue ongoing in the company. All these analysis and research is summed up in a report which is called due diligence report.
In a summarized way, due diligence involves:
- Analysis of various aspects to have an estimate of the commercial potential of an entity.
- Assessment of financial viability of an entity to determine its liabilities and assets
- Examination of the operations and verification of the material facts about the entity’s transactions.
When is Due Diligence Required?
Due diligence is required during the following conditions:
- During the merger and acquisition of the companies
- During raising funds for a startup
- During assets tracking
- Signing a deal or contract
- Investigation of a target company
What is the purpose of Due Diligence?
Due diligence helps the entity to decide by looking at every aspect of the target company. The primary purpose behind due diligence remains the same for every entity i.e., to check the financial and legal stability of the concerned entity and make sure you are well known with the facts and work process ongoing in the company. In short, it enables the establishment to gather as much as information required for which due diligence is executed.
Here are different purposes of due diligence for various entities:
Due diligence in partnership is done for strategic partnerships, alliances, and business coalitions.
For Mergers and Acquisitions:
Due diligence in mergers and acquisitions is done based on the viewpoint of both the seller and buyer. The buyer looks for the information regarding the litigation, finances, patents, etc. while the seller’s main focus is on the business background of the buyer and his capabilities and efficiency to fulfill the commitments and carry on the transactions of the company.
For Public Offers:
Aspects noted during the due diligence of public offers include their decision made on public issues, disclosures, and other compliances and matters.
For collaborations and joint ventures
When a company collaborates with some other company, the main aspects that require due diligence is the reputation of the target company in the market. Knowing about the commitments and resources of an entity becomes very important before joining hands together.
Areas to be focused during Due Diligence:
You need to focus on below-given areas during the process:
- Viability of the concerned entity: Viability is the ability of the company to work. To check the viability of the concerned company, you need to go through their financial business plans thoroughly.
- Healthy Environment: A healthy environment is key to a successful organization. Therefore it’s quite necessary to go through the environment and its impacts on the functioning of the targeted company.
- Monetary aspects: Monetary aspects deal with the cash flow of the company. To evaluate it, the company needs to go through the financial data and ratio analysis of the targeted company.
- Personnel Capabilities: It means to monitor and analyze the capabilities and credibility of the people who are joined with the respective company.
- Technological abilities: Availability and usage of the latest technology are very important to carry out business in a proper manner. Such an analysis would help you to take future actions.
- Litigations and ongoing issues: Any type of litigations and ongoing issues are necessary to be taken into account before making a final decision.
- Synergy Effects: Analyzing the effects of the synergy between the existing and targeted companies would be an efficient decision-making tool.
Types of Due Diligence
Well, from the above information, you would have known how important is due diligence. Now let’s have a look at different types of due diligence:
Administrative Due diligence:
Administrative due diligence deals with verifying administrative aspects such as the number of employees, facilities to the employees, the occupancy rate of the company, etc.
- It helps in evaluating the administrative conditions of the company.
- It provides a clear cut picture of the cost that a buyer has to incur if he plans to join and expand the proposed company.
Asset Due diligence:
It deals with all the details regarding the fixed assets of the target company. It involves mortgages, lease agreements, permits, policies, capital equipment, and real estate.
Financial Due Diligence:
It’s not important what CIM shows are accurate. Financial diligence helps the company go through the actual finances of the company through their capital plans, audited and un-audited financial statements, the projection of the company, their creditors and debtors, customer accounts, cost analysis, profit margins, etc.
Environmental Due Diligence:
Conditions are not the same as we’re in the old times. Nowadays, all companies have to follow the rules relating to environmental laws. In case a company does not follow them, the higher authorities have the full right to impose penalties in turn. Hence it becomes important to go through the environmental audits of the company before making a final decision.
Human Resource Due Diligence:
Human resources are quite extensive and include all labor laws and policies. The company needs to go through the total number of labors and employees their salaries, contracts, policies related to their leaves, policies relating to the problems faced by the employees, health benefits for the employees, insurance policies, grants and ESOPs and many more.
Tax Due Diligence:
In this, all the important tax-related documents and liabilities are checked carefully to ensure proper tax calculation as per the laws. Additionally, it is also important to check whether there are any pending tax-related issues of the target company with the income tax authorities or not.
One should closely scrutinize documents such as income tax return copies, tax audits of the company, tax credits, NOL pertaining documents, etc.
Customer’s Due Diligence:
It includes all the aspects that provide information regarding the customer base of the targeted company. It includes a list of customers and their assets, total and largest purchase, reports of customer satisfaction and reviews, list of customers, loss within the past 3 to 5 years, and others.
Legal Due Diligence:
It includes evaluation and review of legal documents such as a memorandum of association, article of association, minutes of previous shareholder meetings, minutes of the previous board meeting, copies of share certificates and share transfer form issued to the management personnel, franchise agreements and license and other important legal documents.
There are no such specific rules and regulations related to due diligence. However, it is quite an important and significant process that helps to avoid any kind of fraud and maintains transparency between the seller and buyer. It is usually carried out by legal professionals who have enough knowledge and experience regarding the corporate sector of India.