Due Diligence in Due Diligence in Merger and AcquisitionMerger and Acquisition

Jyotsna ChaturvediJyotsna Chaturvedi Senior AssociateSenior Associate

MAHESHWARI & CO.MAHESHWARI & CO. Advocates & Legal ConsultantsAdvocates & Legal Consultants

Telephone: 91-11-2610 1906Telephone: 91-11-2610 1906Fax: 91-11-2617 1201Fax: 91-11-2617 1201

E-mail: jyotsna@maheshwariandco.comE-mail: jyotsna@maheshwariandco.com

Due Diligence in context of M Due Diligence in context of M & A& A

Due Diligence can be defined as the examination Due Diligence can be defined as the examination of a potential target focusing on material future of a potential target focusing on material future matters for aiming to make an acquisition matters for aiming to make an acquisition decision via the principles of valuation and decision via the principles of valuation and shareholder value analysis and getting answers shareholder value analysis and getting answers to key questions, including:to key questions, including:

Do we buy ?Do we buy ?

How much do we pay?How much do we pay?

How do we structure the acquisition How do we structure the acquisition

Need for Due DiligenceNeed for Due Diligence

The standard puts the onus on the buyer to The standard puts the onus on the buyer to conduct a thorough investigation to ensure he is conduct a thorough investigation to ensure he is receiving the benefit of the bargain. receiving the benefit of the bargain. duedue diligencediligence satisfies the officers' and directors' satisfies the officers' and directors' fiduciary duty to make sure any decision made fiduciary duty to make sure any decision made will maximize value for existing shareholders.will maximize value for existing shareholders.

A A duedue diligencediligence audit is the equivalent of audit is the equivalent of checking references before hiring. In general, a checking references before hiring. In general, a duedue diligencediligence audit focuses on information audit focuses on information outside of what is freely presented.outside of what is freely presented.

Advantages of Due Advantages of Due DiligenceDiligence

Improve/validate valuation process

Maximise Synergy

Develop Additional Negotiating Leverage

Identify, Access and reduces risk

Diligence is about

Obtaining Information

Suggesting Solutions

Identifying issues

Analyzing Information

Reasons of FailuresReasons of Failures

Contd.Contd.

All these could be avoided by conducting proper due diligence what we also call 360-Degree Due Diligence (360 3D).

It is a process with a comprehensive approach that engages all the relevant disciplines in order to address all the key issues that are embedded in the target to be acquired.

360 3D360 3D

Legal

Risk Management

HumanCapital

Technical

Operational

Tax

Financial/Accounting

Due Diligence

Steps of Due Diligence

Compiling of Due Diligence Checklist

Procuring Detailed Information/Documents as per the checklist

Analyzing of Information/Documents

Critically evaluating the analyzed information Preparing of a Report with suggestive actions

Compiling of Due Diligence Compiling of Due Diligence ChecklistChecklist

Compiling a due diligence checklist is a resourceful tool when undergoing a merger and acquisition. The checklist assists in covering all business components to ensure that a proper investigation is performed in order to prevent any delays or complications for the involved parties.

Categories

Due Diligence

Stock Exchange Compliances

Property/ Leases CompliancesLabour / HR Compliances

IPRLitigation & Claims

Financial & TaxationEnvironment

Agreements/ Arrangements

Corporate Compliances

Insurance

Corporate Compliances

Complete Group Structure and inter group transactions

Nature of Business of all with their status i.e. dormant or active

Last three years financials of all as submitted to ROC, SEBI and SE

Statutory Registers and Minutes Books

List of all loans (inter-corporate or otherwise), agreed limits, current outstanding and copies of all agreements and other governing documents and Government/RBI approvals, as applicable.

Corporate Contd.

Particulars of any debentures, debenture stock, term loans or other financing arrangements and copies of all agreements and other governing documents.

Copies of all outstanding mortgages, charges, liens or similar arrangements, affecting the company or any of its assets, position of registration of charges with ROC

Property/Leases Title verification of purchased and leased properties.

Land use/ sanctioned plan compliances.

Utilities (electricity/water) compliances.

Examination of leases to ensure Company’s interests is adequately protected with no hidden potential liabilities.

Proper stamping and registration of property documents

Municipal taxes and local tax compliances

Litigation, Investigation & Claims

Review of all investigations, legal action, disciplinary proceedings (including pending or threatened) against the Company and its Directors since its incorporation, by governmental or other bodies or individuals or organizations.

Review of any order, judgment or decree of any Court, governmental or regulatory body to which the Company is associated or by which it is bound.

Review of dispute/proceedings, if any, pending before any quasi-judicial authorities.

Litigation Contd.

Review of any current litigation/arbitration or other disputes in which the Company is presently involved or may become involved or any settlements entered into with respect to any litigation.

Intellectual Property Rights

Review of all copyrights, trademarks, service marks, patents and other intellectual property (including all applications thereof) owned/licensed/assigned/registered and copies of all agreements and instruments relating to/involving the acquisitions, assignment, licensing, ownership and registration thereof.

Review of all non-disclosure agreements and/or confidentiality agreements executed by the Company.

Labour/HR Compliances Business activities, office locations & hours of

work for each office of the Company.

Details regarding outsourcing/contract labour:

Do the contractors / outsourcing agency pay wages, control and supervise their employees, grant leave, do performance appraisal, take disciplinary action and otherwise perform all the functions of an employer qua their employees?

Whether the Company is exempted from complying with any Labour Legislations.

HR Contd. Details of registration of the Company with

various statutory authorities (if applicable) for e.g. - ESI, PF, and Miscellaneous Provisions Act, Industrial Employment Standing Order’s Act, Shops & Establishment Act , Factories Act .

How is Provident Fund being paid to the employees employed by the Company? Details of company’s contribution to Employees Provident Fund along with the rates and proof of upto date payment.

Details of Bonus etc. if any of the Company.

Environment

Licences, permissions, authorizations and consents from environmental authorities

Details of any breach of any law, code

Details of any environmental management committee reports (if any)

Hazardous materials, spills, emissions etc. of the Company

CCI in M & A

All M & A with combined turnover of Rs 4,500 crore or more will require approval of CCI from June 1, with an objective to safeguard interests of consumers and promote industrial growth

Some major Failures

Survey conducted by McKinsey and company shows Survey conducted by McKinsey and company shows that many parent companies often over estimate the that many parent companies often over estimate the value of target company due to lack of due diligence.value of target company due to lack of due diligence.

In 1998 the German auto car maker Damlier Benz In 1998 the German auto car maker Damlier Benz merged with Chrysler Group for a value of $36 billion. merged with Chrysler Group for a value of $36 billion. It was perceived to be a merger between equal but It was perceived to be a merger between equal but after a few years, the value of Chrysler fell to a mere after a few years, the value of Chrysler fell to a mere $7.4 billion and the merger had proved to be a failure$7.4 billion and the merger had proved to be a failure

The failure was attributed to inability to conduct due The failure was attributed to inability to conduct due diligence It over estimated the value of the target diligence It over estimated the value of the target company which led to the merger being unsuccessful.company which led to the merger being unsuccessful.

How due diligence saved a How due diligence saved a company from big fraudcompany from big fraud

A small Canadian exploration firm, Bre-X Minerals A small Canadian exploration firm, Bre-X Minerals Ltd., announced that it had made one of the Ltd., announced that it had made one of the world's largest gold discoveries containing some world's largest gold discoveries containing some 3-4% of the world's reserves which soared the 3-4% of the world's reserves which soared the value of Bre-X shares giving the company a value of Bre-X shares giving the company a market capitalization higher than that of several market capitalization higher than that of several major mining companies.major mining companies.

Eventually, Bre-X proposed to form a partnership Eventually, Bre-X proposed to form a partnership with Freeport-McMoRan, a U.S. company. Before with Freeport-McMoRan, a U.S. company. Before making a firm commitment, Freeport insisted on making a firm commitment, Freeport insisted on carrying out due diligence.carrying out due diligence.

Contd.

The results shook the mining industry; Bre-X The results shook the mining industry; Bre-X contained no significant gold After the scam was contained no significant gold After the scam was uncovered, the Bre-X share price crashed, and uncovered, the Bre-X share price crashed, and disgruntled shareholders (who lost about $3 disgruntled shareholders (who lost about $3 billion) began taking legal action against the billion) began taking legal action against the company.company.

Consensus of Minds!!!