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Due diligence
- 2. © Oxford University Press 2011. All rights reserved.
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.
- 3. © Oxford University Press 2011. All rights reserved.
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."
- 4. © Oxford University Press 2011. All rights reserved.
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.
- 5. © Oxford University Press 2011. All rights reserved.
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
- 6. © Oxford University Press 2011. All rights reserved.
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.
- 7. © Oxford University Press 2011. All rights reserved.
Transactions requiring Due Diligence
Mergers and Acquisitions:
Personnel
Financial Operations
Marketing
Property and Equipments
Business Operations
Strategic Alliances and partnerships
Joint Ventures and Collaborations
- 8. © Oxford University Press 2011. All rights reserved.
People Involved in Due Diligence
Financial
Legal
Operational
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Parties interested in Due Diligence
Employees
Trade Unions
Shareholders
Creditors
Vendors
Customers
Government
Society
- 11. © Oxford University Press 2011. All rights reserved.
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.
- 12. © Oxford University Press 2011. All rights reserved.
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.
- 13. © Oxford University Press 2011. All rights reserved.
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
- 14. © Oxford University Press 2011. All rights reserved.
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
- 15. © Oxford University Press 2011. All rights reserved.
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.
- 16. © Oxford University Press 2011. All rights reserved.
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.
- 17. © Oxford University Press 2011. All rights reserved.
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.
- 18. © Oxford University Press 2011. All rights reserved.
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
- 19. © Oxford University Press 2011. All rights reserved.
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
- 20. © Oxford University Press 2011. All rights reserved.
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.
- 21. © Oxford University Press 2011. All rights reserved.
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
- 22. © Oxford University Press 2011. All rights reserved.
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.
- 23. © Oxford University Press 2011. All rights reserved.
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
- 24. © Oxford University Press 2011. All rights reserved.
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
If the transaction was fraudulently designed to escape liability.
- 25. © Oxford University Press 2011. All rights reserved.
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
- 26. © Oxford University Press 2011. All rights reserved.
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
- 27. © Oxford University Press 2011. All rights reserved.
Regulators might sue over:
antitrust (in suits brought by government)
environmental law
health and safety law
- 28. © Oxford University Press 2011. All rights reserved.
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 or
Change 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
- 29. © Oxford University Press 2011. All rights reserved.
Suppliers might sue over:
antitrust (in suits brought by suppliers)
business interference
contract disputes
copyright/patent infringement
deceptive trade practices
- 30. © Oxford University Press 2011. All rights reserved.
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
- 31. © Oxford University Press 2011. All rights reserved.
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
- 32. © Oxford University Press 2011. All rights reserved.
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.
- 33. © Oxford University Press 2011. All rights reserved.
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
- 34. © Oxford University Press 2011. All rights reserved.
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.
- 35. © Oxford University Press 2011. All rights reserved.
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.
- 36. © Oxford University Press 2011. All rights reserved.
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.
- 37. © Oxford University Press 2011. All rights reserved.
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
- 38. © Oxford University Press 2011. All rights reserved.
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
- 39. © Oxford University Press 2011. All rights reserved.
Why Due Diligence fails?
Failure to Focus on Key Issues
Failure to Identify New Opportunities and
Risks
Failure to Allocate Adequate/ Right
Resources