How to Perform Due Diligence (Step-By-Step Guide)

How to Perform Due Diligence (Step-By-Step Guide)

In the world of globalisation, a number of business transactions have come to pass and the process has become effortless. This is because of a due diligence process.

It is analysing everything about the target company before entering into a potential deal.

It is a detailed investigation of the financial statements of the target company to understand the financial performance of the company. 

Due diligence makes merger & acquisition to be genuine as the financial health of the target company is known. This helps in assessing risk associated with the business purchase transaction.

How due diligence process is performed

Due diligence is performed prior to the company being purchased by the acquirer and it helps in taking informed decisions for the investment.

First Step - Analyse the purpose of the Project  

First step in the process of due diligence is to evaluate the project goal. 

It helps to garner information and in locating the required resources for the due diligence process and lastly to align with the underlying strategies of a company.

Second Step - Pre Analysis of Business Financials  

This step helps in checking the accuracy of financials shown in Confidentiality Information Memorandum (CIM). 

Therefore, it reviews the financial statements, assets, debts and projections. 

However, it helps in knowing the overall financial health of a company. 

It is a deep analysis of historical trends to confirm the relevance of these trends.

Third Step - Full checks of documents 

Process of due diligence helps in having a thorough inspection of documents. 

It is the prime step of the process. The buyer, before acquiring any company, asks for the audited accounts or any relevant documents which the company requires and can visit any of the sights if the buyer wants, as it helps in satisfying the buyer/ investor before entering into an agreement. 

Therefore, disclosure of pedantic information is very much important for the closure of potential deals.

Fourth Step - Full analysis of the business case and plans

Here, the buyers make a full analysis of the business plans and models of the target company. 

This is to assess whether it is viable for the buyer to enter into an agreement. 

It is the foremost process, for closing the potential deal, reviewing and analysis of plans and models of business, of the target company.

Fifth Step - Risk Analysis

Risk analysis is analysing the risk attached to the target company. 

The process is initiated to target any risk involved in the proposed transaction. 

This is the crucial step of the Financial due diligence process as it determines the risk attached to the potential deal, and whether the deal is positive to accept or not. 

During this process, the unforeseen problems are examined, as to rectify them before entering into an agreement.

Sixth Step - Final Offering Creation and Ongoing Monitoring 

When all the information is garnered, reviewed, and analysed, the teams evaluate and share their findings.

Documents required for Due Diligence

  • Memorandum of Association
  • Articles of Association
  • Certificate of Incorporation
  • Shareholding Pattern
  • Financial Statements
  • Income Tax Returns
  • Bank Statements
  • Tax Registration Certificates
  • Tax Payment Receipts
  • Statutory Registers
  • Property Documents
  • Intellectual Property Registration or Application Documents
  • Utility Bills
  • Employee Records
  • Operational, Legal and another document

Frequently Asked Questions (FAQs)

Q1. Is financial due diligence important before completing the merger agreement?

Yes, it clearly states the financial health of the target company which is important before entering into the agreement.

Q2. Who conducts financial due diligence?

Financial due diligence is conducted by the acquiring party. An acquiring party can perform due diligence with an in-house team or can outsource to due diligence professionals.

Q3. What is a due diligence checklist?

  • Identify the stock - Identify the stock 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, and 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)?

Q4. What do you mean by tax Due Diligence?

Tax due diligence helps in gaining the existing tax structure of the target company. It assesses the unutilised tax opportunities and presents any tax risk available. Tax due diligence is to investigate the target company’s unrecognised taxes and tax expense if any.

Q5. Who is the tax preparer of due diligence?

The tax preparer determines the information of tax, whether it is correct or not. Given by the taxpayer. Any tax liability arises, which is not paid off and is to be cleared. Tax preparers must keep the document for at least 3years. The preparer must inquire about the information, they appear to be correct and complete.

Q6. What is intellectual property due diligence?

Intellectual property means an intangible asset like patents, copyrights, trademarks and trade secrets which are owned and legally protected by the company or individual. 

Intangible assets are a non-physical asset which is owned by the company or a person. Intellectual property is the most valued asset of the company.

Q7. What are the objectives of due diligence in M&A transactions?

Objective is to make an investor/ buyer, the right decision about the investment. It also conducts a SWOT analysis to identify the strength and weaknesses of the target company.

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