Due diligence plays an important role in making an informed decision in any Business
Due diligence plays an important role in making an informed decision while any business deals and transactions are taking place. It helps in estimating the risks involved in any business dealing, and most importantly, it is crucial to know in advance, whether the deal actually fits in an organization’s portfolio.
During mergers and acquisitions (M&A), the potential deal involves various types of due diligence, especially while acquiring IP. It is all the more crucial when India has become an attractive destination in terms of Foreign Direct Investment (FDI) after the announcement of FDI Policy 2020 which allows FDI through automatic route in most of the sectors barring defense, pharma, insurance, media, telecom, etc.
Obviously, such a scenario throws open a wide window of opportunity for mergers, acquisitions and collaborations. Amidst all these, due diligence for IP has assumed even greater significance.
Due diligence regarding the issue of stocks, bonds, sales, and marketing, IT networks is also critical for any successful M&A. To make an informed decision, various types of due diligence are discussed herein below:
Intellectual Property (IP) Due diligence
Intellectual property assets form the backbone of any company or business, hence it is important to confirm the accuracy of all the claims made by the seller of IP assets. Under this diligence, an audit is done to assess the quantity and the quality of IP assets possessed by, or licensed to, a company, business, or an individual. It also includes an assessment of how intellectual property is acquired and protected by the concerned company or business.
The IP due diligence is necessary to ensure that all kinds of IP assets can be monetized efficiently to drive the business. IP assets include all existing patents as well as applications for new patents, schedules of copyrights, brand names, trademarks, and any pending patents clearance documents, among others. All these items are required to be verified while dong IP due diligence.
Administrative due diligence
When any M&A deal takes place, it is imperative to do proper due diligence to verify all the claims made by the seller. Assessment of all operational costs comes under administrative due diligence. The idea of undertaking this due diligence is essentially to verify the various facilities owned or occupied by the other party and determine whether all operational costs are accounted for in the paper-work and documentation or not. The buyer must undertake administrative due diligence to verify whether details of various facilities occupied or owned by the seller are factually correct.
Asset due diligence
It typically involves the details of fixed assets and the verification of locations, besides verification of the schedule of sales/purchase of the capital intensive equipment, especially bought during the last three to five years of time. The buyer must verify all the real estate deeds, title policies, and use permits to complete the process of asset due diligence.
Environment due diligence
Due diligence related to environmental regulations has become extremely important in the current times that require growing awareness regarding the environment. Under environment due diligence, copies of environment audits are checked with an eye over all the required environmental permits and relevant licenses, besides scrutinizing contingent environmental liabilities (if any), or any continuing indemnification obligations.
Simultaneously, to avoid getting trapped into any pending penalty on the part of the firm, it is necessary to review the copies of all the notices and correspondence received from the local and state regulatory environment protection agency and authorities. The country’s Environment Protection Act proposes stringent penalties against unscrupulous violators of environmental preservation and conservation.
Financial due diligence
In order to check the financial aspects, it is necessary to do the financial due diligence that ensures the authenticity of the financials of the concerned company. It provides a detailed understanding of the company’s exact financial status. For this purpose, the company’s audited financial statements for the last three years are thoroughly checked.
In addition to it, the unaudited financial statements and the company’s projections are also verified and studied. Under financial due diligence, the buyer should also verify the company’s capital expenditure plan and details regarding the obligations of debtors, and creditors.
Human resources due diligence
Considering that human resources are the most important assets of any company, human resources due diligence should be done prior to the signing of the M&A deal. For this purpose, it is very much required to analyze the total number of employees with complete details regarding their current positions and profiles. The overall vacancies in the firm should also be known and an in-depth analysis of the total currently payable salaries is a must.
The acquiring company should also know about the details of the bonuses paid by the concerned company at least during the last three years. The analysis of the company’s HR policies regarding different kinds of leave and LTA sanctions offered to the employees is also done under human resources due diligence.
Apart from all these, employment contracts should be analyzed properly by taking into consideration all the HR policies regarding any potential discrimination, harassment at workplace, and all other matters. If there are any pending legal cases against any current or former employees, or if there are any labor disputes, all the required details and status of such cases should be properly obtained and verified under this kind of due diligence.
Due diligence regarding tax liability
It is also very much necessary at the time of M&A. The entire tax liability of the company should be reviewed apart from verifying any tax-related case that may have been pending with the tax authorities to avoid any future complications. The documents under verification while doing taxes due diligence include GST, income tax, the erstwhile sales tax papers as well as the information regarding any pending tax audits.
Legal due diligence
It is carried out in a most professional and meticulous manner to properly examine all the necessary legal documents. The important legal papers needed to be verified during the process of this due diligence include copies of memorandum and articles of association as well as minutes of all the meetings, board resolutions, and actions of shareholders pertaining to the last three years.
Legal due diligence also includes verification of copies of all share certificates, guarantees, material contracts, partnership and joint venture contracts, among many other documents. Verification of all the loan/bank financing agreements is also done under legal due diligence.
Another very important aspect is to check the details of all ongoing litigations against the target firm or put by the firm in all the different courts and other authorities throughout the country or even overseas.
Customer due diligence
It is another very important verification that includes acquiring knowledge about such customers of the company who make the largest total purchase on a regular basis. For this purpose, service agreements, besides credit policies and customer feedback forms within the last 3-5 years are closely verified.
Simultaneously, due diligence is also required for understanding whether the target firm fits well into the expansion strategy of the company. Towards this end, it is ensured whether the target company possesses strategically important products, technology as well as market access to make their optimum profitable use.
Of course, the due diligence process is a time consuming, tedious and expansive process but at the same time, it’s critical to make the M&A a win-win situation for both the parties concerned. Despite the knowledge of the financial field possessed by the staff, it’s not a good idea to evaluate your company’s financial health by your internal means only. It is always advisable to hire a professional agency to avoid any mistake that may take place in business processes due to even a little oversight or negligence.
In nutshell, while doing due diligence, all the documents and business records must be minutely verified through professionals qualified and competent to carry out this exercise in order to immediately find out any discrepancies in the claims made by the other party and to alert and prepare the buyer/investor for it in advance.