Duediligence 130522013210-phpapp02

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Chapter 4

Due Diligence


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 deciding whether to acquire another i.e. evaluating whether the buy is good or bad.


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 Staff 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


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 special purpose accounts.


Types of Due Diligence

Financial Due Diligence:

involves evaluating a company’s 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

assets, as well as the value of fixed assets.


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 the underlying assumptions used


Legal Due Diligence:

Scrutiny of all, or specific parts, of the legal affairs

of the target company with a view of uncovering

any legal risks and provide the buyer with an

extensive insight into the company’s legal matters

Improves the buyer’s 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 company’s strong and weak sides, relevant risks and advantages in connection with the transaction,

Minimizing the risk of unexpected situations, Improvement of the seller’s bargaining position, Identification of areas where representations and

warranties from the seller should be obtained in the acquisition agreement.


Documents verified

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

Confidentiality and invention assignment agreements with employees

Tax and financial documents

Legal disputes and other kinds of conflicts

Marketing practices regulation

National and EU-competition 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

May also cover investigation outside of the actual

business.


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 valuing the contribution of HR Helps 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 HR Information System (HRIS) and Employment Litigation


Litigation Analysis

When one company sells or otherwise transfers all its assets to another company, the successor is not liablefor 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

If the transaction was fraudulently designed to escape liability.


Components of Litigation Analysis

Customers -- as well as competitors, suppliers, and other contractors—might 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 unions—might 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 law

health and safety law


Shareholders might sue over:

Contract disputes (with shareholders)

Financial transactions (such as derivatives)

Investment or loan decisions

Divestitures or spin-offs Fraudulent conveyance M&A scenarios (target, bidder)

Dividend declaration orChange duties to minority shareholders

General breach of fiduciary duty

Proxy contents

Executive compensation (such as golden parachutes)

Inadequate disclosure Recapitalization

Financial performance/bankruptcy

Insider trading Share repurchase

Stock offerings


Suppliers might sue over:

antitrust (in suits brought by suppliers)

business interference

contract disputes

copyright/patent infringement

deceptive trade practices


Does Due Diligence insure against M & A failure? Helps avoid:

Able to avoid unnecessary losses and expenses

The organization’s governing body is able to demonstrate that it has engaged in effective 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 organization’s 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, cost-effective 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.


Effective Due Diligence team

Have members with first hand experience in the industry to which the target belongs

Have members with expertise in different 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


Thank you!

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