Due Diligence(1)

7/31/2019 Due Diligence(1)

1/35

Page 1

Due diligence


2/35

Page 2

Due diligence meaning andprocess


3/35

Page 3

What iS due diligence?

Due diligence isused to investigate

and evaluate abusiness

opportunity.

Due diligenceserves to confirm

all material facts inregards to a sale.

refers to the care areasonable person

should take beforeentering into anagreement or atransaction withanother party


4/35

Page 4

Due diligence is aprocess of thorough

and objectiveexamination that isundertaken beforecorporate entities

enter into majortransactions such asmergers and

acquisitions, issuingnew stock or othersecurities, project

finance, securitization,

etc.

One of the keyobjectives of due

diligence is tominimize, to themaximum extentpracticable, the

possibility of therebeing unknown

liabilities or risks.

The exercise is multi-dimensional and

involves investigationinto the business, tax,financial, accounting

and legal aspects of anissuer.


5/35

Page 5


6/35

Page 6

The process starts with the

sourcing of the fund opportunity.

an investor will either beapproached directly or indirectly(through a placement agent) by

the fund manager

Investors examine the type andpositioning of the fund, evaluatethe historic track record, make

an initial assessment of the teamand the organization and ensure

that there are no obviousdealbreakers.

If the investor is satisfied that the

fund meets its preliminarycriteria, full due diligence begins.


7/35

Page 7

Due diligence process-evaluate a basket of both quantitative and

qualitative factors


8/35

Page 8

people

Assessment of the managers team, organization, individualsexperience, remuneration structure

Multiple face-to-face meetings, including visits to all the managers

offices, Interviews with investment professionals, alone, and in groups,formally and informally and at various levels in the organization

Detailed reference checks with portfolio company management, otherprivate equity professionals, bankers, accountants, lawyers, investors,and previous colleagues, including leavers from the firm

Ownership and remuneration analysis, including fee income andbreakdown of carried interest


9/35

Page 9

process

Assessment of the managers deal sourcing, due diligence,monitoring and exit process

Complete portfolio review, including a Responsible Investment (RI)review of portfolio companies

Assessment of the managers previous due diligence work,including checks on portfolio company files and monitoring

systems.

Assessment of the managers compliance and risk managementprocesses, including back office audit and an understanding of howthe manager has integrated RI into its investment and reporting


10/35

Page 10

Philosophy and investment strategy

Assessment of the consistency and suitability of the managersstrategy, and its execution

Understanding of the market within which the fund manager operates.

Comparison of strategy and positioning with private equity managerstargeting the same or similar markets (whether or not they arecurrently in the market with a new fund).

Analysis of trends in previous portfolios of the fund manager)

Evaluation of the managers ability to carry out the funds stated

strategy in the future.


11/35

Page 11

performance

Assessment of the managers track record, areas of value-add and repeatability

Slice and Dice analysis: evaluation, verification andattribution analysis of the managers track record, includingperformance breakdown by deal executive, geography.

Understanding of the managers valuation policy and

reasonableness thereof;

Comparison of exit values against the last stated value of aportfolio company, again to test for reasonableness of themanagers valuation process


12/35

Page 12

Portfolio fit and legal review

Assessment of the funds terms and conditions andstrategic fit within the fund portfolio

Suitability and fit within the investors overall portfolio.

Legal document review and comparison with best

practice

Reporting provisions, quality of information flow toinvestors, membership of the Advisory Board, and

accessibility to the manager


13/35

Page 13

Once the investor hascompleted the due diligence

stage, negotiation of theterms of the fund can

proceed.

Many investors try to enter afund at its first closing, so thatthey can have a greater sayin setting the terms of the

fund.

After the closing takes place,the investor needs to set up amonitoring process to conduct

ongoing evaluation of themanager and the

performance of the fund

work is involved for both theinvestor (in assessing a fund)and the manager (in working

through the investors duediligence process) that

investors and managers try tobuild long term relationships


14/35

Page 14

Due diligence checklist

A comprehensive business information request listsent from a private equity firm to a seller to assist thebuyer in conducting a thorough business review.

Due diligence checklists are typically prepared andforwarded once a buyer is in exclusivity with the seller.

most information requests are somewhat predictableregardless of the buyer, much of the information

requested may already have been provided in the dealdata room.
http://www.pedatabase.com/private-equity-glossary/term.php/93/General/Private-equityhttp://www.pedatabase.com/private-equity-glossary/term.php/95/Transaction/Due-diligencehttp://www.pedatabase.com/private-equity-glossary/term.php/51/Transaction/Exclusivityhttp://www.pedatabase.com/private-equity-glossary/term.php/51/Transaction/Exclusivityhttp://www.pedatabase.com/private-equity-glossary/term.php/95/Transaction/Due-diligencehttp://www.pedatabase.com/private-equity-glossary/term.php/93/General/Private-equity


15/35

Page 15

I. Financial Information

A. Annual and quarterly financialinformation for the past three years

1.Income statements, balance sheets, cashflows.

2. Planned versus actual results

3. Management financial reports

4. Breakdown of sales and gross profits by:

a. Product Type b. Channel

c. Geography


16/35

Page 16

B. Financial Projections

Major growth drivers

Predictability of business Risks (e.g., exchange rate fluctuation,

government instability)

Industry and company pricing policies Explanation of projected capital

expenditures,


17/35

Page 17

C. Capital Structure

1. List of all stockholders with

shareholdings, options, warrants

2. Schedule warrants, rights.

3. Summary of all debt instruments

4. balance sheet liabilities


18/35

Page 18

II. Products

A. Description of each product

1. Major customers and applications

2. Historical and projected growth rates

3. Market share

4. Speed and nature of technological change

5. Timing of new products, product

enhancements

6. Cost structure and profitability


19/35

Page 19

III. Customer Information

A. List of top 15 customers for the past two fiscal years(name, contact name, address, phone number, product(s)owned, and timing of purchase(s)

B. Revenue by customer(name, contact name, phone number for any accounting for 5percent or more of revenue) C. Brief description of any significant relationships

severed within the last two years.(name, contact name, phone number)

D. List of top 10 suppliers for the past two fiscal years

information(name, contact name, phone number, purchase amounts,supplier agreements


20/35

Page 20

IV. Competition

A. Description of the competitivenesswithin each market segment including:

1. Market position and related strengths

and weaknesses as perceived in the

market place

2. Basis of competition (e.g., price,

service, technology, distribution


21/35

Page 21

V. Marketing, Sales, andDistribution

A. Strategy and implementation

B. Major Customers

C. Principal avenues for generatingnew business

D. Ability to implement marketing plan

with current and projected budgets


22/35

Page 22

VI. Research and

Development A. Description of R&D organization 1. Strategy

2. Key Personnel

3. Major Activities B. New Product Pipeline 1. Status and Timing

2. Cost of Development

3. Critical Technology Necessary forImplementation

4. Risks


23/35

Page 23

VII. Management and

Personnel A. Organization Chart B. Summary biographies of senior management,

including employment history, age, service withthe Company, years in current position

C. Compensation arrangements 1. Copies (or summaries) of key employment

agreements

2. Benefit plans

D. Discussion of incentive stock plans E. Significant employee relations problems, past

or present


24/35

Page 24

VIII. Legal and Related

Matters A. Pending lawsuits against theCompany

B. Pending lawsuits initiated byCompany

C. Description of environmental andemployee safety issues and liabilities

D. List of material patents, copyrights,licenses, and trademarks


25/35

Page 25

Challenges

Consistent application of criteria

Various firms indicate that their process isoutlined and documented but tends to be

more institutional. Formal documentation isnot fully utilized.

the fundamental elements of the screeningand due diligence process should createvaluable time to explore the details of apotential investment opportunity


26/35

Page 26

Capturing knowledge andexperience

efforts to enhance ones learning curvebecome critical in facilitating the capture ofknowledge.

Often it becomes necessary to haveknowledge that is narrow and deep tointimately understand a particular market /technology space.

This intimacy with a particular space leads toimproved handling of the due diligenceprocess.


27/35

Page 27

Proactive Research

Often firms are focused on their core expertiseand are not able to devote sufficient time andresources to exploring new market spaces.

Firms often comment that, if time allowed, they

would like to devote resources to understandingnew market space opportunities through extendingtheir knowledge and core competencies.

The ability to not only identify new market space,but to also identify the specific companies, could

create a significant potential advantage for firms.Therefore, improving the process of due diligenceshould create time to devote to other endeavours.


28/35

Page 28

PRECAUTIONARY MEASURES

COMPANIES TAKE BEFOREENTERING A DUE DELIGENCE

AGREEMENT


29/35

Page 29

1 Make sure a business is worth buying

should verify the information you have

been given about your prospective new

business

It should also highlight any issues or

problems which might need warranting orguaranteeing.


30/35

Page 30

There are traditionally three types of due

diligence you should do.

You might need different advisors for each:

legal due diligence - as part of a salesand purchase contract, the lawyers can

check that the business has legal title to

sell, ownership of all the assets and that

regulatory and litigation issues are fully

addressed


31/35

Page 31

financial due diligence - checking thenumbers and making sure there are no

black holes orhidden financial issues

commercial due diligence - finding outthe business' place in the marketplace,

checking competitors and the regulatory

environment


32/35

Page 32

2. WHEN TO BEGINDon't start due diligence until you have agreeda price and terms with the seller.

They may agree to take the business off themarket during your investigation.

This is known as an exclusivity period - andthe seller will often ask for a down payment tosecure it.


33/35

Page 33

3. Help

Ideally you should get accountants and

solicitors to help you identify risk areas but, if

it is registered with Companies House, you

can also obtain copies of the company

accounts, the annual return and the otherkey documents filed by your target business

using the Companies House WebCHeck

service.


34/35

Page 34

Key areas to cover are:

employment terms and conditions

outstanding litigation

major contracts and orders

IT systems and other technology

environmental issues

commercial management including customer

service, research and development, and

marketing


35/35

Page 35

4. Information sources

Dig as deeply as you can and use whateverdocuments are available.

For instance, if you're looking at employee records, youcould check out:

payroll records

staff files copies of pension and profit-sharing plans, plus

financial statements, if relevant

employment contracts

the staff manual union contracts, if relevant

You may also need information from externalsources such as the landlord, tax office or bank.

Due Diligence(1)

Documents

Transcript of Due Diligence(1)