Due diligence is the detailed investigation and verification of potential deals to confirm all the relevant financial information related to it.
This process is completed before the deal is done. It gives Assurance to the Buyers About what they are buying and for that companies hire Due diligence Service providers.
Table of Content
1. Due Diligence
2. Importance of Due Diligence
3. Why is Due Diligence done?
4. Types of Due Diligence
5. Documents required for Due Diligence
6. Soft Due Diligence
7. Due diligence for Startups
8. Due Diligence for Stocks
9. Due diligence checklist
10. Cost of Due Diligence
11. Types of cost in M&A transactions
12. Due Diligence activities in M&A Transactions
What is Due Diligence
Due diligence is a detailed investigation and verification of financial records before entering into a financial transaction. Due diligence is done to target any risk involved in the proposed transaction.
This process occurs before acquiring any business or a company. This is a boundless process which is performed by the acquiring firm in order to assess the financial transactions.
Importance of Due Diligence Services
1. Determines the risk attached to the company’s target and the amount of contingent liability.
2. Transactions which undergo the process provide higher chances of success.
3. Identifies any shortcomings in a company's target.
4. Properly examines the unforeseen problems which can be rectified before entering into an agreement.
5. Without undergoing due diligence in merger & acquisition, it can increase the risk for the purchaser.
Why is conducting due diligence important?
It is done to have an exhaustive understanding of the financial statements of a company, so the investor can make intelligible decisions, about whether to invest in the company or not.
Mergers and Acquisitions of business are put through a due diligence process.
Acquiring firm checks the terms and conditions of another firm as to whether it is favourable or not by taking Due Diligence Services.
The Professionals go through the assets and liabilities of the firm and check whether it is profitable to acquire that firm or not and also assess the risk attached to the contract.
Due diligence Audit gives you confidential information about the company before entering into the agreement or before signing the contract.
Different Types of Due Diligence
1. Financial due diligence: It is the exhaustive understanding of company financials. It is one of the most important types of due diligence. A key area of financial due diligence is to review the financial statements, assets, debts and projections to whether it’s true and correct.
2. Legal due diligence: This typically includes examination and review of the following documents:
- Copy of Memorandum of Association
- Copy of Article of Association
- Minutes of Board meetings for the past three years
- Copy of share certificate
- Partnership agreement
- Licence agreement
3. Administrative due diligence: This involves admin-related items. Any operational risk involved should be addressed.
4. Asset due diligence: This process provides details about the fixed assets and their locations (Physical verification can be done, if possible). All the agreements of equipment and schedule of sale or purchase are to be reviewed.
5. Human Resource due diligence: It is an extensive and most underestimated type of due diligence. It covers the whole gamut of the workplace and all the documents regarding employees and management.
6. Environment due diligence: Environment Protection Agency (EPA) sets the regulations and standards for this purpose. EPA is the one, who determines which type of assessment is to be done. Documents to be reviewed, like environmental permits, licence, and copies of notice from EPA.
7. Tax due diligence: It means examining and reviewing the tax liabilities, if any due, of the company. Due diligence is to investigate the unrecognised tax or any of the tax related issues. Making mistakes in tax due diligence can lead to heavy penalties from the government.
8. Intellectual Property due diligence: Intellectual property is an intangible asset which almost every company has, to monetize or construct their business. Few items to be looked at in due diligence, like copy of patents, copyright, trademark etc.
9. Customer due diligence: It includes a close look at the company’s customer base. It involves examination and analysis of customer satisfaction score, service agreements etc..
Documents Required During Company Due Diligence
1. Memorandum of Association
2. Articles of Association
3. Certificate of Incorporation
4. Shareholding Pattern
5. Financial Statements
6. Income Tax Returns
7. Bank Statements
8. Tax Registration Certificates
9. Tax Payment Receipts
10. Statutory Registers
11. Property Documents
12. Intellectual Property Registration or Application Documents
13. Utility Bills
14. Employee Records
15. Operational, Legal and other documents
What Is Soft Due Diligence
Soft due diligence is concerned with the people within the business and the customer base of a company.
It reviews the compensation packages, benefits and other incentives which are to increase the well-being and happiness of employees.
It also analyses the customer's response to any change in operations and cultures, any change in operations of a company will impact the customers.
Due diligence for Startups
Due diligence gives a detailed assessment of a company and it will give the startup a good breakdown of its strengths and weaknesses.
It reveals unexpected risks that you might not be aware of and gives opportunity to the startups to gain potential investors as someone will make your business grow and guide you, as someone will dig you or harm your business.
Due Diligence for Stocks
It is very different from a stock valuation. Due diligence is a very common process when making investment decisions. It has nothing to do with the attractiveness or unattractiveness of the stock.
Complete Due diligence Checklist
- Identify the stock - Identify the stock by yourself of a particular sector.
- Understand the Business - The Stock is not just an asset which represents a company. Therefore, you need to gain knowledge and know about the company’s business. By what methods the company is earning income.
- Market Capitalisation of Target Company - Market capitalisation is very much crucial as it depicts the potential size of its market.
- Is the company financials strong? - Crucial aspect of due diligence is to ascertain the financial health of a company. You can see the Income Statement, Balance Sheet, Cash Flow Statement. You can evaluate the company’s profit, analyse the company’s debtor cycle etc..
- Company Management - It is very essential to know how strong the company management is. What are the credentials of the management (top management & founders).
Who pays for Due Diligence Services?
The costs are incurred by both the parties, the buyer and seller. They pay for their own team of investment bankers, accountants, attorneys and other consulting personnel.
The due diligence Services cost highly depends on the duration of the process, which depends on the complexity of the target company.
In this case the cost is referred to as capital expenditure. By capitalising the cost, the company can increase its profit.
9 Types of Cost in M&A transactions
1. M&A Advisor Fees
2. Deal Related Cost
3. Legal Fees
4. Breakage Fees
5. Integration Advisory Fees
6. IT & Technology Cost
7. HR Cost
8. Debt Servicing Cost
9. Rebranding Cost
Due Diligence Activities in M&A Transactions
Financial Strength: Examine the financial statement and future projections. The Vendor must provide the financial statement for the last three years.
1. Are the margins of a company growing or not?
2. Is the financial statement audited?
3. Can we believe the future projections?
4. The required amount of working capital to continue the business?
5. Any outstanding debt and its term?
Target Company Overview: Why the seller is selling the company. What are the goals of a company and a business plan? Any complexity is attached to the company. Whether the company has been acquiring another company or merged with any company.
Patents: All the patents exist in the company. What measures are taken to protect the patents of a company? What are the registered trademarks and service marks with the company? Does the business of the seller depend upon any trade secrets?
Employee/ Management: The buyer will understand the quality of seller management and employee base. Details of any disputes among labour. Sexual harassment and misconduct allegations or cultural issues.Current employment benefits. What are the current policies?
Legal Matters: Details of litigation settled and on what terms. Any matter in arbitration. Filed or pending litigation.
Why choose Especia?
Especia is committed to provide assistance throughout the process. We tender productive advice at every stage of the process. Choosing Especia makes your work very easy and systematic. We have a dedicated and motivated team and we provide Proficient solutions to your complex problems.