Today, many companies are involved in merger and acquisition activities. An investor acquires the target company but before acquiring detailed research of a company is required for a smooth and seamless deal.
Here comes the role of due diligence, the services provide detailed investigation and verification of potential deals to confirm all the relevant financial information related to it.
Due diligence examines the unforeseen problems which can occur and it also helps in rectifying them before the agreement takes place.
This process is initiated to target any risk involved in the proposed transaction. Due diligence is the process which occurs before acquiring any business or a company.
There are different Types of Due Diligence
1. Financial due diligence
Financial due diligence is the exhaustive understanding of company financials.
It is one of the most crucial and important types of due diligence.
Financial DD checks the accuracy of financials shown in the Confidentiality Information Memorandum (CIM).
A key area of financial due diligence is to review the financial statements, assets, debts and projections to whether it’s true and correct.
The aim is to have an understanding of the overall financial performance of the target company and detect any issues there.
2. Legal due diligence
Legal due diligence is an investigation by viewing, collecting and assessing the documents and information of the target company.
It’s the process to assess the legal risk of the target company during the M&A process.
Legal due diligence typically includes examination and review of the following documents:
- Copy of Memorandum of Association
- Copy of Article of Association
- Minutes of Board meetings for past three years
- Copy of share certificate
- Partnership agreement
- Licence agreement
3. Administrative due diligence
The administrative due diligence involves admin-related items. Any operational risk involved should be addressed.
This area of due diligence verifies the policies, rules and regulations are in accordance with the government policies. Consider all the activities in operation and the process.
4. Asset due diligence
This process is to have the 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 is to be reviewed.
5. Human Resource due diligence
Human Resource due diligence 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.
This investigation aims in achieving the target company’s organisational structure, benefits and compensation plans for employees.
6. Environment due diligence
The 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, 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.
Therefore, it helps in gaining the existing tax structure of the target company. Clients use the information to decide post-M&A tax planning.
8. Intellectual Property due diligence
Intellectual property means an intangible asset like, patents, copyrights, trademarks and trade secrets which is owned and legally protected by the company or individual.
Almost every company has to monetize or construct their business. Intellectual property due diligence helps in maximising the value of assets.
Therefore, the due diligence is to identify the risk attached for a proper deal between buyer/investor and seller.
9. Customer due diligence
Customer due diligence always includes a close look at the company’s customer base.
It involves examination and analysis of customer satisfaction score, service agreements etc.
10. 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.
It’s the process in which the startups can look for potential investors as someone will make your business grow and guide you, as someone will dig you or harm your business.
Due diligence is a very costly and time-consuming process for the investor.
If the investor is investing the cost and the time in your startups that means the investor is very much positive about your company.
Frequently Asked Questions (FAQs)
Q1. What is due diligence for Stocks
Due diligence 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.
Q2. Who bears the Cost of Due Diligence?
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 cost highly depends on the duration of the process.
Q3. Why does Due Diligence matter?
Due Diligence helps both the parties, the buyer and seller in business acquisition. It helps the investor to make wise decisions in closing the deal. This information helps to learn about the current situation of the existing company, nature of the deal.
Q4. Why is Due Diligence done?
It is done to have an exhaustive understanding about the financial statements of a company, so the investor can make intelligible decisions, whether to invest in the company or not.
Q5. What’s the difference between earnest money and due diligence?
Earnest money is the good faith money paid by the buyer to the seller. A payment made, shows the interest of the buyer. Earnest money is negotiable as well as refundable. If the buyer is in default, or breaches any contract, then the money remains with the seller.
Whereas, the due diligence is non- refundable. Only when the seller breaches any contract, the money can be refunded.