Due Diligence (1)

8/18/2019 Due Diligence (1)

1/51

DUE DILIGENCEDUE DILIGENCE

Prof.C.S.Balasubramaniam


2/51

CONCEPTCONCEPT

It’s a proactive management tool.

Taking every reasonable precaution.

It is essentially an investigation to manage risks.

Systematic, structured research efort toascertain and accumulate acts necessary tomake an inormed investment “decision”.

In common parlance, a care that a reasonable

person or organiation e!ercises under speci"ccircumstances to avoid harm to themselves orothers.


3/51

DEFINITION AND MEANING OF DUEDEFINITION AND MEANING OF DUE

DILIGENCEDILIGENCE

# measure o prudence, activity, or assiduity, as is properlye!pected rom, and ordinarily e!ercised by, a reasonable andprudent man under the particular circumstances.” Black’s Law Dictionary with Pronunciations, sixth edition 1994, p. 457

$ue $iligence is a process o investigation undertaken byvarious lenders including banks and "nancial institutions orassessing the perormance o business.

The process o investigation perormed by investors into thedetails o a potential investment such as e!amination ooperations and management and the veri"cation o materialacts.


4/51

HISTORICAL BACKGROUND OF DUEHISTORICAL BACKGROUND OF DUE

DILIGENCEDILIGENCE

The term $ue $iligence %as "rst used under &SSecurities #ct, '()) as $ue $iligence $eence.

$ue diligence deense is generally used by

brokers*dealers or inade+uate disclosure toinvestors.

Initially, $ue $iligence %as restricted to Initialublic -fer I-/ only but overtime 0ergers

and #c+uisitions etc. also ound the place. $ue $iligence helps to get the realistic picture

o business today and tomorro%.


5/51

OBJECTIVES OF DUE DILIGENCEOBJECTIVES OF DUE DILIGENCE

To spot out the evils, %hich may invite someunanticipated liabilities in uture.

To orecast the uture perormance o anorganiation by analying the potential risksand threats.

To help in identiying liabilities, negotiate a lo%erprice, avoid la%suits and costly mistakes and top oall to make good business and "nancial decisions.


6/51

DUE DILIGENCE

WHY DO YOU CONDUCT A DUE WHY DO YOU CONDUCT A DUE

DILIGENCE?DILIGENCE?

1ssential to determine the hidden risks %hich areattached to the transaction as it may result in thetransaction being aborted or afect the purchaseprice or terms o the agreement.

Transactions involve substantial "nancial obligations.

The need or $ue diligence is sought to unearth the

secrets %hich every business tend to have one.

2ood 3orporate 2overnance


7/51

WHY - DUE DILIGENCE? WHY - DUE DILIGENCE?

Investment

Risk Assessment

4alidate assumptions o Inormation

0emorandum&nderstanding Investment 5eturn 6 5i

ro"tability 7erormance 5atios5-31 vis*8*vis 3ost o 3apital3ash 9lo% analysis

Identiy

otential #d:ustmentsotential 5isk71!posures-f balance sheet e!posures

NegotiationValuation


8/51


Shock Absorber

Identiy Inormation not presented;egal -%nership encumbrances

Shareholders #greement3ontingent liabilityIndemnity7?arranties

Identiy structuring issues > e.g. ;ease 6 buy


9/51


Enhance

Understanding

Identiy 2ro%th $rivers and &S#nalye resent @ey =usiness $rivers

5evie% bottlenecksStrategy or utureSystems 6 ersonnel * inormation


10/51

DUE DILIGENCE vis-à-vis AUDITDUE DILIGENCE vis-à-vis AUDIT

$ue $iligence is ar beyond the"nancial analysis. #udit is concerned%ith the truth and airness o historical

"nancial statements only.

$ue $iligence can be conducted by any

o the proessionals %hereas #udit is tobe conducted mandatorily by the3hartered #ccountants.


11/51

STATUTORY AUDIT & DUE DILIGENCE

REPORT DDR! "A COMPARISON

$e"ned Tailor 0ade

Statutory Audit DDR

LegalReuirement

Sco!e

0andatory


12/51

STATUTORY AUDIT & DUE DILIGENCE

REPORT DDR! "A COMPARISON

#ppointed by the

company

#ppointed by either the

buyer or the seller

Statutory Audit DDR

Attitude

A!!ointment

?atch*$og Investigator

Em!hasis True 6 9air 3ommercial #spects

Issues concerning Term sheet


13/51

TRADITIONAL V#S VIRTUAL DATATRADITIONAL V#S VIRTUAL DATA

ROOMROOM

Traditional $ue $iligence$ata 5oom > $ata isavailable in a la%yer’soBce or conerence room

4irtual $ue $iligence $ata5oom > $ata is accessedthrough the internet.


14/51


ROOMROOM

Location * # traditional data room is usually located at anearby la%yer’s oBce to increase security. This also increasescosts. # 4irtual data room is located on a secure server at athird party data center.

E#ort * Traditional data room %ill re+uire the printing andinde!ing o many electronic documents, "nancial spreadsheetsand contracts. ?hile many paper documents must be scannedto create the electronic images or a virtual data room all o theelectronic documents can be processed online.

Security * ?ith a la%yer’s oBce the security is only as good asthe paralegal %ho is in the room taking care o the documents.I implemented correctly a virtual data room can be moresecure than a la%yer’s oBce. Dou can restrict %ho sees %hatdocuments and %ho can copy %hat documents.


15/51


ROOMROOM

$ost % # Traditional data room is not as cheap as the 4irtual dataroom ater you add up the labor to copy and inde! all thedocuments plus the legal oBce space to manage a multi %eekdata room efort.

Record Activity & In a Traditional data room you cannot record%ho sees %hat document, %herein in a 4irtual data room,ho%ever, one can have daily reports o %ho vie%ed at %hichdocuments.

Document Revie'ers & In a 4irtual data room one can keeptrack o %ho revie%ed %hich documents, on the other hand such

an advantage is lacked in a traditional data room.

Lo'er Investor Risk & There is less investor risk involved in thecase o a 4irtual data room as compared to a Traditional dataroom.


16/51


ROOMROOM

(ulti!le )idders % # 4irtual data room by itsnature can allo% all users to access the samedocuments concurrently and in private.

Ne' In*o Distribution % =idders %ill oten submit+uestions and re+uest additional data. ?ith a4irtual data room is very easy to add ne%documents to the data room and notiy everyone oits posting.

Restrict Access & In a 4irtual data room the accessto the inormation may be restricted to speci"c 7authorised people.


17/51

VARIOUS TYPES OF DUE VARIOUS TYPES OF DUE

DILIGENCEDILIGENCE

TD1S

=&SI


18/51

BUSINESS DUE DILIGENCEBUSINESS DUE DILIGENCE

=usiness $ue $iligence aims to ensure that the buyer gets all thematerial acts re+uired to make a ully inormed decision andassessment o the true condition o the business %hile not disruptingthe seller’s business unduly.

Timing is critical. It is best to %ork out some type o planned schedulein advance so everyone’s e!pectations are met and %e do not havedisagreements or unnecessary delays.

It includesE -perational due diligence

Strategic due diligence Technical due diligence 1nvironmental due diligence

Auman 5esource due diligence


19/51

FINANCIAL DUE DILIGENCEFINANCIAL DUE DILIGENCE

9inancial due diligence analyes, +ualitatively and+uantitatively, ho% an organiation has perormed "nanciallyto get a sense o earnings on a normalied basis.

It includesE 5evie% o accounting policies 5evie% o internal audit procedures The +uality and sustainability o earnings and cash Fo% The condition and value o assets, liabilities and potential

liabilities

#ccounting systems and controls Ta! implications o deal structures 1!amination o key operational processes 1!amination o inormation systems to establish the reliability o

"nancial inormation


20/51

LEGAL DUE DILIGENCELEGAL DUE DILIGENCE

;egal $ue $iligence is about the managemento risk.

The ;egal $ue $iligence covers t%o aspects >intra*corporate transactions and inter*corporatetransactions.

;egal $ue $iligence investigations give themost complete picture o a company.


21/51

LEGAL DUE DILIGENCELEGAL DUE DILIGENCE

The investigation or inspection %ould coverE 3ompliance %ith local la%s Securities or other regulatory violations or disciplinary actions 1!tensive litigation and7or bankruptcies > assessment o

easibility o pursuing litigation

9inancial statements &npaid ta! liens and7or :udgments ast business ailures and related debt 9raudulent or e!aggerated credentials 0isrepresentations or character issues $iscoveries and disclosures

#ssets > real and intellectual property, brand value 5eputation and good%ill 3ross*border issues > double ta!ation, oreign e!change

Fuctuation, sovereign risk, investment climate, culturalimpact on human resources.


22/51

SECRETARIAL DUE DILIGENCESECRETARIAL DUE DILIGENCE

Secretarial $ue $iligence ensures thatthe targeted company has duly complied%ith the corporate la%s and regulations

and other applicable provisions, i any.

It reers to the secretarial audit o the

company.


23/51

DUE DILIGENCE

SELECTION OF A DUE DILIGENCESELECTION OF A DUE DILIGENCE

CONSULTANTCONSULTANT

3larity o ob:ect

Sie o the organisation

@ey 3oncept to be kept in 0ind

#void G3asualG $ue $iligence 3onsultants 3onsider an 1nd*to*1nd rovider =e%are o Aidden Interest 0ulti *9unctional 1!pertise Secure ;ong*Term 5elationships %ith Dour

3onsultant

Selecting the =est 9irm


24/51

SELECTION OF A DUE DILIGENCESELECTION OF A DUE DILIGENCE

CONSULTANTCONSULTANT

3lient base o the 3onsulting #gency

0eetings should be arranged

Terms 6 3onditions should be discussed beorehand

3onsultant should be selected vigilantly


25/51

CRUCIAL FACTORS TO BE CONSIDERED WHILECRUCIAL FACTORS TO BE CONSIDERED WHILE

CONDUCTING DUE DILIGENCECONDUCTING DUE DILIGENCE

=e prepared %ith E # detailed listing o the e!act due

diligence steps to ollo%

# checklist o everything to complete ineach due diligence area

Speci"c due diligence tasks that need to

be completed #ll o the materials you need rom the

seller beore you start


26/51

CRUCIAL FACTORS TO BE CONSIDERED WHILECRUCIAL FACTORS TO BE CONSIDERED WHILE

CONDUCTING DUE DILIGENCECONDUCTING DUE DILIGENCE

#llo% yoursel time

Inormation rom vendors and customers

#nalyse "nancial as %ell as ollo%ing key actorsE

The management team’s past perormance, roles andtalent

-rganiational strategy and business plans

5isk management structure

Technological superiority

#de+uacy o inrastructure

Internet 5esearch


27/51

PROCESS OF CONDUCTING DUEPROCESS OF CONDUCTING DUE

DILIGENCEDILIGENCE

reparation o $ue$iligence 5eport

$ata #nalysis

lanning

$ata 3ollation


28/51

28

PLANNINGPLANNING

Scope and 3ore areas

#ppointment o the team *Skills7e!pertise

3lear and de"nite mandate

$e"ning the time schedules* ho% to deal%ith challenges %ithin agreed time rame

%ith available resources Timely communication o inormation

re+uirements $ue $iligence 3hecklist/


29/51

DATA COLLATIONDATA COLLATION

5esearch or data could be either+ualitative or +uantitative

-ne on one intervie%s %ith management

rom the target company $ata room and access to the room Sources E Internet, 3ompetitors, Industry

associations, 5egulatory organiations

and databases %hich %ill includesearches o public registers, 3ustomers,4endors etc.


30/51

DUE DILIGENCE

DATA ANALYSIS

&nderstanding everything you can about thecompany

It should be done keeping in mind the ob:ectiveso $ue $iligence

The analysis o due diligence "ndings is generallya %eighing o a variety o actors in order to

determine %hether team should give a positiverecommendation eg E business criticality,unctional comple!ity, technical comple!ity,inrastructure re+uirements etc.


31/51

PREPARATION OF DUE DILIGENCE

REPORT

# summary o the scope o the revie%

# list o all the inormation disclosed by investigations

#n analysis o the documentation and inormation

revealed

#n e!ecutive summary %hich outlines the legal issuesidenti"ed and advises on the legal implications oproceeding %ith the transaction 5isks and ;iabilities/

Aighlight the material issues arising rom the duediligence revie% and advice on the actors inFuencingthe price to be paid


32/51

ROLE OF PROFESSIONALSROLE OF PROFESSIONALS

INVOLVED IN DUE DILIGENCEINVOLVED IN DUE DILIGENCE

+ro*essionalsinvolved in Due

Diligence

3ompany Secretaries

3hartered#ccountants

3ost #ccountants

#dvocates 7 Solicitors 9inancial #nalysts

+ro*essionals should

have

1!pert kno%ledge

#nalytical 6business advisoryskills

3larity o ob:ect

3on"ning to timerame anddeadlines


33/51

AREAS RE$UIRING DUE AREAS RE$UIRING DUE

DILIGENCEDILIGENCE

[A] MERGER, AMALGAMATION AND ACQUISITION

$ue diligence is a comprehensive undertaking in cases opotential mergers and amalgamation

Track record o the past as %ell as uture prospects o the

company is re+uired to kno% so as to identiy the potentialgro%th o the company. -ne should incorporate an element o ob:ective sel*analysis. To complete the $ue $iligence %ithin a reasonable period o

time,* either

outsource the $ue $iligence task to a reputable research "rm or

build an eBcient in*house program %ithin their legal, marketing, orcorporate security sectors.

# detailed assessment o the market and target o the proposedac+uisition should also be clear prior to closing a deal.


34/51

DUE DILIGENCE


DILIGENCEDILIGENCE

In todayHs ast*changing businessenvironment, one should look into ollo%ingareasE

9inancial 5esearch and $evelopment

Intellectual roperty

0aterial #greements

#ssets7;iens

1mployment*related matters

3orporate Issues

;icensing and ;itigation


35/51


DILIGENCEDILIGENCE

[B] PARTNERSHIP -ne should conduct negotiations and investigation into

afairs o the entities beore entering into partnership.

$iferent types o partnerships %here due diligence

investigation is re+uired to be doneE Strategic #lliances, Strategic artnerships

=usiness artners and #lliances, artnering #greements,

Technology and roduct ;icensing, oint $evelopment#greements, Technology Sharing and 3ross ;icensing

#greements =usiness artners, #Bliates, 9ranchisees and

9ranchisers.


36/51


DILIGENCEDILIGENCE

[C] INTELLECTUAL PROPERTY

# detailed assessment o Intellectual roperty I/assets has become an increasingly integrated part.

$ue diligence process involves investigation o aparty’s o%nership, right to use and right to stopothers rom using the I rights involved in sale ormerger.

Thorough internal assessment o its o%n assets can

enhance I planning and management. #c+uiring or investing in a business that o%n I

assets re+uire the scope and depth o due diligence.


37/51


DILIGENCEDILIGENCE

CORE AREAS OF IP:'/ Signifcan !a"n i##$"# > Scope o rights > 5ights transerable

>Issues raised by license agreements, other rightstranser agreements >5evie%ing7evaluating all pending7threatened

inringement claims7enorcement opportunities etc.

J/ Signifcan c%!&'ig( i##$"# > #ssignment and 5egistrations in roper -rder > 2rants 1fective > 5ights Transerable


38/51


DILIGENCEDILIGENCE

)/ Signifcan 'a)"*a'+ i##$"#

> # list o all licenses, ranchises, royaltyagreements, or similar

arrangements related to the target companyand7or products

> Third party use

> olicing7licensing

K/ Signifcan 'a)" #"c'" i##$"#

L/ Signifcan )%*ain na*" i##$"#


39/51


DILIGENCEDILIGENCE

,D]INITIAL PUBLIC OFFER IPO-

$ue $iligence plays a key role in an I-.

Tool to optimie potential o the company,thereby increasing its value to potentialinvestors.

$ue $iligence is re+uired to be conductedby the 0erchant =ankers.


40/51


DILIGENCEDILIGENCE

Aelps to identiy any potential shortalls in3orporate 2overnance issues or "nancialreporting procedures so that the company is

able to take corrective action prior to listing. re*I- $ue $iligence process %ill result in a

gap analysis bet%een the present status othe company and the company that should

be Foated. It identi"es the %eaknesses and strengths o

the company.


41/51


DILIGENCEDILIGENCE

rovides comort in preparing aprospectus in accordance %ithSecurities 0arkets #ct.

#llo%s the management and leadmanager to assess the reasonablenesso the statements made in theprospectus as re+uired by la%.

Aelps the lead manager to understandthe business o the corporation and themain risks associated %ith it.


42/51

DUE DILIGENCE

CAUTIONSCAUTIONS

Sensitivity by seller 7 issuer access ocon"dential data to investors, especially%hen the latter are e!isting competitors.

3on"dentiality #greements E ;imiteddisclosure to counter*party and its advisors%ith an obligation to return data in case

deal alls through.


43/51

DUE DILIGENCE

BOTTLENECKSBOTTLENECKS

sychological Issues

Inormation -verload

$elay in reply to important +ueries * “divert

attention” Inormation provided in bulky ormat > Aard copies

%ith unimportant details

ractical 3ommercial Issues 9inancial 6 #ccounting Scandals


44/51

DUE DILIGENCE

BOTTLENECKSBOTTLENECKS

$isapproval rom the company.

-utcome o the $ue $iligence rocess may beconsciously or unconsciously tainted by

o%ners, managers and researchers %ho standto bene"t personally or proessionally rom theproposed activity.

$ue $iligence is a diBcult and e!tensivee!perience.

It is comple! since more negatives may beestablished or envisaged.


45/51

DUE DILIGENCE

CASE STUDY CASE STUDY

# ma:or &S 3ompany intended ac+uiring an independent =-3ompany in India. The =- 3ompany as per their claims had ane!cellent line up o clients and credentials. They also claimed

large business activity in Singapore.

The &S 3ompany %anted the due diligence team to "nd out i theac+uisition candidate %as indeed as sound as %as made tobelieve, beore they began any discussions %ith them.

The team’s investigations ound that the =- 3ompany hadstarted perorming %ell only in the recent past, and that they%ere a group o companies and not one company, one o thecompanies o the group %hich had the same set o romoters and$irectors, had been sued against in the &S or roduct ;iability.


46/51

DD is % Mi'(-G%)*+ ,*.**' S*//*0

%'( DD T*%)111


47/51

TIPS FOR EFFECTIVE DUETIPS FOR EFFECTIVE DUE

DILIGENCEDILIGENCE

1!haustive list o re+uirements.

;ook or contradictory inormation or replies.

#sk +uestions %here the intentions 7 ob:ectives aredisguised so that the replier cannot manipulate the reply.

;ook at comments o Internal #udit 5eports.

In case o resistance in providing inormation try to "gureout %hy the inormation is being %ithheld.

Track the time period %ithin %hich the replies are provided.


48/51

TIPS FOR EFFECTIVE DUETIPS FOR EFFECTIVE DUE

DILIGENCEDILIGENCE

Is the tone o reply deensive or attacking.

;ook at transaction post ;etter o Intent ;-I/ and pre$ue $iligence 5eport $$5/.

;ook or deerment or e!pedition o transactions.

5evie% transactions %ith related parties and Transer

ricing olicy or group company transactions.

Scrutinie the legal and proessional charges.


49/51

CONCLUSIONCONCLUSION

G$ue $iligenceG is simply a phrase usedto describe %hat are generally, “businessinvestigations”. It is commercial :argonor the detailed analysis and risk revie%o an impending commercial transaction.

#de+uate $ue $iligence helps the buyerto ascertain the current business

conditions

status on pending litigations negotiation o purchase price decide on the proposed investment


50/51

CONCLUSIONCONCLUSION

FORE.ARNED ISFOREARMED

CA/EAT EMPTOR

LET THE BUYER BE.ARE-


51/51

Due Diligence (1)

Documents

Transcript of Due Diligence (1)