Due Diligence is a process of research and analysis usually undertaken by accounting or consulting firms. This exhaustive process is taken before a merger or acquisition of an organization, making an investment, entering into partnerships, granting of bank loans to corporate borrowers, vendor selection and even employee Hiring.
A prospective investor would need to make sure that he has a reasonable assessment of the value of the stake which he intends to acquire and that there are no hidden issues or liabilities in the business. Usually the due diligence exercise needs to be done within a reasonable time frame but with a wide scope and in substantial detail. As such, investors typically entrust this task to experts who are well-versed in due diligence and therefore are able to do a thorough check on the financial, tax and compliance position of the company within the limited transaction timeline.
Due Diligence providers prepare a report with a business analysis, setting out the observations on the business by materiality/importance and helps the acquirer in decision making and negotiation.
Due Diligence can be of various types:
- Financial including Tax
Financial Including tax Due Diligence:
In any investment, it is imperative to understand the historical financial statements, accounts and compliances. Through the due diligence, the expert can trace the primary revenues, costs, assets and liabilities as well as see the macro trends in the business, identify low-performing segments or non-core assets, etc. A due diligence also checks whether there are any hidden or contingent liabilities and how they would impact the business in future. Are the profits consistent or erratic? Have the assets been valued properly? Has the company ensured that taxes are up to date? A financial due diligence attempts to answer all these questions.
Legal Due Diligence
In any M&A process, legal risks need to be covered in terms of statutory compliances including treatment of taxes, drafting of letter of intents, agreements including Share Purchase agreements (SPA).
Environment Due Diligence
This is normally done when acquiring a commercial property especially in certain industries with a high risk of environmental impact. The key concern areas would be related to whether the property has hazardous materials, or if it is situated in flood zone or a protected environment.
Technical Due Diligence: This includes the assessment of the technological feasibility vis-à-vis the transaction.
Forensic Due Diligence:
This is primarily an investigation into the background of the promoters of a company in case of M&A, for an employee during hiring process and vendor selection process.
Due Diligence is a critical activity in any transaction, which helps to identify and minimise the risks associated with the transaction as well as assist in negotiations. It also helps in creating a post-merger or post-acquisition plan after closing any business deal. For this, it is imperative that domain experts are part of the team which provides integrated services. For example, consulting Firms could have Chartered Accountants, legal advisers, MBAs, engineers, Company Secretaries and other domain experts in their team.