DUE DILIGENCE

DR. RAJINDER S. AURORA

What is Due Diligence?

Implies

an activity involving either the performance

of an investigation of a business or person, or the
performance of an act with a certain standard of
care

Also

used to mean a required legal obligation

although the term more commonly applies to a
voluntary investigation

Examples:
Steps carried out by venture capitalists before and
during each investment phase of a start-up
company
Precautionary steps taken by one company in

What is Due Diligence?

Banking

Industry - To act in a prudent manner

in evaluating credit applications.

Securities

Market - Responsibility of underwriters

to explain the details of new securities to
interested purchasers.

Legal

Definition - A measure of prudence, activity,

or assiduity, as is properly to be expected from, and
ordinarily exercised by, a reasonable and prudent
person under the particular circumstances; not
measured by any absolute standard but depends on
the relative facts of the special case."

Activities of Due Diligence

Financial

Statements:

Review and confirm the existence of assets, liabilities, and

equity in the balance sheet to determine the financial health
of the company based on the income statement.

Management and Operations review:

Determine quality and reliability of financial statements to

gain a
sense of contingencies beyond the financial statements.

Legal Compliance Review:

Check the potential future legal problems stemming from

the target's past.

Document and Transaction review:

Ensure paperwork of the deal is in order and that the

structure of the transaction is appropriate.

Need for Due Diligence

Strengths

and weaknesses of the business

Gives

a fair value of the investment

Helps

in identifying the apparent irregularities

Tool

of ensuring that the prevailing system of

checks works

What does Due diligence involve?

Historical

Financial Data
Current Financial Data
Forecasted Financial Information
Business Plans
Minutes of Directors Meetings and
Management Meetings
Audit Paper Work Files
Contracts with Suppliers, Customers and Staf
Confirmation/ Representations from
Financiers, Debtors, etc.

Transactions requiring Due Diligence

Mergers

and Acquisitions:

Personnel
Financial Operations

Marketing

Property and Equipments

Business Operations

Strategic

Alliances and
partnerships
Joint

Ventures and Collaborations

People Involved in Due Diligence

Financial

Legal

Operational

Parties interested in Due Diligence

Employees

Trade Unions

Shareholders

Creditors

Vendors

Customers

Government

Society

Steps in Due Diligence Process

Planning
Phase

Data
Collection
Phase

Data Analysis
Phase

Report
Finalization
Phase

Planning Phase
Defining
the
Scope

Deciding
the Focus
Area
Finalizing
the Team
Structure
Clear
definition of
Responsibiliti
es
Defining
time
schedules

Sustainability of
Business
Financials
Competition
Management Team and Organizational
Culture Potential Liabilities
Technology
Existing market
potential Business to
Business fit
Timely
communicati
on of
information

Finalizing
templates
and tools
required

Due Diligence Reporting

Should

reflect a fair and independent analysis &

evaluation of financial and commercial information

Should

ensure collection, analysis and interpretation

of financial, commercial and tax information in
detail

Should

provide properly reviewed and

analyzed financial information to bidders
and various stakeholders

Should also provide a feedback on auditing of

the

Types of Due Diligence

Financial Due Diligence:
involves

evaluating a companys historical,

current, and prospective operating results as

disclosed in its historical, current and projected
financial statements, tax returns, and other
information
Involves

analysis of balance sheet, review from

cash to marketable securities, receivables,

inventory, prepaid expenses and other current

 Analysis

on the liability side includes accounts

payable, taxes, and debt obligations must be

closely examined

Helps

in getting a sense of future

revenues
Evaluates

used

the underlying assumptions

Legal Due Diligence:

Scrutiny

of all, or specific parts, of the legal

afairs 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
Improves

the buyers bargaining position and

ensures that necessary precautions in relation to

the transaction are taken

Objectives of Legal Due Diligence

Gathering

of information from the target

company,
Uncovering of the target companys strong
and weak sides, relevant risks and
advantages in connection with the
transaction,
Minimizing the risk of unexpected situations,
Improvement of the sellers bargaining
position,
Identification of areas where representations and
warranties from the seller should be obtained in
the acquisition agreement.

Documents verified
Confidentiality
and
invention
assignment
agreements
with
employees
Tax and financial
documents

IT law and IT contracts

Intellectual property rights
Patents, copyrights, and
other intellectual
property- related
documents
Company law
Financing
Employment law
Data protection law
Consumer protection law
General contract law
Minutes and consents of
the board of directors and
shareholders

Legal disputes and

other kinds of conflicts
Marketing
practices
regulation
National and EUcompetition
law

Public
procurement law.

Operational Due
Diligence:
Involves

the on-site analyses of the target

business
daily processes and of how the business operates.
Analysis

includes an evaluation of the key

employees, managers, independent

contractors, suppliers and other factors
necessary for the business to conduct normal
operations

 Includes

examining work centres, material flow,

scrap generation, and inventory levels to identify
improvements required to improve productivity
and profitability
Helps identify and implement changes necessary
to increase EBITDA and increasing the multiples
due to lower risk.
Involves gathering information on:

New product or service creation

Markets
Competition
Sales Targets
People/Organizational matters

Intellectual Property Due

Diligence
Through

analysis needed in this area as

economies
are increasingly becoming technology driven
process

of identifying all intellectual property

assets, verifying ownership and ensuring that

such assets are free of encumbrances for the
intended business use is fundamental to any
merger, acquisition or investment

 Examples

range from the ingredients and

manufacturing process for coke, a closely guarded

trade secret, to the many domestic and
international trademarks owned by multinational
conglomerates such as Tata, HUL, Reliance, etc.

IT Due
Diligence;
Involves scrutiny of IT systems and processes in
use and ascertaining better ways of deriving
value and leverage from IT assets
Involves:

Sending an IT request list to the acquired company

Compiling an onsite discovery process outline
Conducting a review of the requested materials
Scheduling and coordinating the onsite visit

Human Resource Due

Diligence:
Involves
Helps

valuing the contribution of HR

by:

Establishing a link between organizational objectives and the HR

function
Determining HR's influence on the skills and motivation of the
workforce

Determining the managers views of the HR function

Ascertaining the outcomes produced by the HR deliverables

Measuring the adequacy of HR measures, metrics and

benchmarks

Ascertaining the total cost of the HR function and industry

comparisons

Ascertaining the HR team structure, skills and motivation.

Areas covered
Organizational

culture
Executive compensation and golden
parachute contracts
Collective bargaining agreements and
potential change of ownership liabilities
Defined benefit and contribution pension
plans
Postretirement benefits
Retention and severance plans
Health and welfare insurance structure and
reserves
HR functional structure and service delivery

Litigation Analysis
When one company sells or otherwise transfers all
its assets to another company, the successor is not
liable for the debts and tort liabilities of the
predecessor.
Successor may be liable, however, under
the following circumstances:

If it has expressly or implicitly agreed to

assume liability
If the transaction is a merger or consolidation
If the successor is a mere continuation of the
predecessor

Components of Litigation Analysis

Customers -- as well as competitors, suppliers, and
other contractorsmight sue over:
contract disputes
cost/quality/safety of product or service
debt collection, including foreclosure
deceptive trade practices
dishonesty/fraud
extension/refusal of credit
lender liability
other customer/client issues
restraint of trade

Employees -- including current, past, or

prospective employees or unionsmight sue
over:
breach of employment contract
defamation
discrimination
employment

conditions
harassment/humiliation
pension, welfare, or other employee
benefits
wrongful termination

Regulators might sue

over:
antitrust (in suits brought by
government)
environmental
health

law

and safety law

Shareholders might sue

over: disputes
Contract
Financial transactions Investment or loan
(with
(such as derivatives)
shareholders)
Divestitures or spin-ofs Fraudulent conveyance

decisions

Dividend declaration
or Change duties to
minority shareholders

Proxy contents

General breach
of fiduciary duty

Executive
Inadequate disclosure
compensation (such as
golden parachutes)
Financial performance/
bankruptcy

Insider trading

M&A scenarios
(target, bidder)

Recapitalization

Share repurchase
Stock oferings

Suppliers might sue

over:
antitrust (in suits brought by
suppliers)
business

interference

contract

disputes

copyright/patent
deceptive

infringement

trade practices

Does Due Diligence insure against

M&A
failure?
Helps avoid:

Able to avoid unnecessary losses and expenses

The organizations governing body is able to

demonstrate that it has engaged in efective oversight
and

Senior officers of the company avoid job- and

bonus- threatening adverse events

Due Diligence involving Financial

Issues
Can lead to significant unbudgeted liabilities and
the diversion of time and energy of key
executives
Helps identify fictitious bills and fictitious originals
created such as the signature-authority list.
Helps identify dormant bank accounts for they
are a breeding ground for manipulative practices.
Unexpected voiding of invoices from the
organizations accounts receivable system should
be investigated, particularly if your organization is
structured so that people who have the ability to
void an invoice also have the ability to receive or
issue cheques

Due Diligence Involving

Organizational
Records
Periodic

review of the minutes of board

meetings
needs to be done.
Record

retention policies are often advocated

across countries as a reliable tool of
reference.

Due Diligence involving Legal

Compliance
Helps ensure that the organization is in
compliance with applicable law
Depending

on the nature and size of an

organization, professional advisors should be
engaged to evaluate the laws and regulations
as applicable, and to help management design
a due diligence plan

Compliance

can be achieved in an orderly,

costefective and timely manner

Due Diligence involving Interaction of

Contracts
Involves

due diligence of key contracts

and agreements, and summarizing and
cross- referencing

Critical for future reference

Help in avoiding inadvertent conflicts.

Due Diligence involving Information

Systems
Helps

to get tuned to the rapid shift from

manual system infrastructure to technology
driven infrastructure.

Ensures adherence to regulatory compliance

that
are coming into force.

Due Diligence involving Key

Customers and
Suppliers
Strong

need to initiate ongoing monitoring of the

operations and plans of key customers and
suppliers as can reveal important information
on its current financial and operational status
and near- term future events.

Also

reveal a deteriorating financial condition

in advance.

Efective Due Diligence team

Have

members with first hand experience in the

industry to which the target belongs
Have members with expertise in diferent areas such
as HR specialists, Functional area managers,
individuals with knowledge of national culture, etc.
Capable of quickly identifying both the positive and
negative aspects of the property to be acquired.
Willing to carry out a site visit to evaluate the current
condition of the assets to be acquired; both the
physical assets as well as the personnel
Have members who possess excellent negotiation
skills
Have people who have time to lead the project and
serve as team members

 Ensure

that the diligence team is co-located within a

secure environment, such as a corporate headquarters
or closer to the target
Be familiar with the strategic and financial rationale
behind the acquisition
Train the team to identify and home in on specific issues
Develop and communicate rules of engagement
between
the diligence team and the target company
Make available analytical tools and techniques so the
team can rapidly get its arms around potential
synergies and integration challenges
Healthy flow of information

Why Due Diligence fails?

Failure

to Focus on Key

Issues
Failure

to Identify New Opportunities

and Risks
Failure

to Allocate Adequate/ Right

Resources

Any
Questio
ns
Please?
???