Check out this blog for detailed information about due diligence, its requirements, impact, types, and how it is performed in India.
Due diligence is done for a variety of reasons, but the primary purpose is to ensure that all material information is disclosed to potential investors. This allows investors to make informed decisions about whether or not to invest in a company. Additionally, it can help identify any potential risks associated with an investment and can provide negotiating leverage for potential investors. In this blog, we’ll take a closer look at the process of due diligence and why it’s so critical for anyone looking to make smart business decisions.
Process of Due Diligence
In India, due diligence is done to review a company’s assets and liabilities, its structure, operations, and business relationships, which are also assessed, thus helping in finding out the company’s health. A company initiates due diligence before making any business sale, bank loan funding, private equity investments, future acquisition, and others. During the process of due diligence, the company’s legal compliance and financial details are analysed and documented. It helps evaluate and realise how correct a decision regarding a future acquisition, a partner, or a buyer is. It also prevents you from committing any mistakes during decision-making. The main objective of this exercise is to ensure that the business being considered for acquisition is legally and financially sound and that all important facts of the same are known to you and documented.
Requirement of Due Diligence
Due diligence is an important before making decisions regarding purchasing, selling, or investing in partnerships. During this processof due diligence , the assets and liabilities, standing and functioning of the business, financial liquidity, goodwill, and other factors are assessed. It is also judged on how stable and sound the company is. It helps an individual evaluate and understand various aspects of the property.
Impact of Due Diligence
A non-disclosure agreement between both parties is made before the process of due diligence is initiated. This is done as a precaution since sensitive, operational, financial, legal, and regulatory information is available to the buyer for evaluation. It provides the buyer with important information to review and make an informed investment decision and also helps eliminate any risks during the business purchase transaction.
Categories of Due Diligence
It is classified into the following four categories
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General Due Diligence
Any individual can follow the process of due diligence. A person in his daily life can also adopt due diligence by planning for the day according to the weather/temperature, and deciding whether the transport will be regular or changed. He will also look and decide on other relevant factors.
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Due Diligence in investment
It helps an investor in finding out potential risks when investing. Analysing all the factors will make him invest in what is best for him.
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Due Diligence in business
If an individual/ company is planning to enter a partnership, merger, or purchase another business due diligence should be applied. This will give them a clear picture of the business’s current status, and they can make a correct decision.
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Due Diligence in negotiation
When entering an agreement all parties must put forward their understanding and expectations to safeguard everyone’s interest. This exercise is also a form of due diligence.
Types:
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Administrative
This helps an individual to keep track of various facilities/ units functioning under the company. This gives him a clear picture of the operational costs, number of employees, and an idea of the future costs to be incurred to meet and expand the company’s targets in case he purchases it.
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Financial
It checks whether the financial details shown in the Confidentiality Information Memorandum are accurate.
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Asset
This involves all information related to a fixed asset. The documents related to fixed assets like lease agreements for equipment, real estate deeds, mortgage, title policies, use permits, and all sales and purchases of significant capital equipment too are analysed.
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Human Resources
It involves several labour laws and policies. Under this, an analysis is made of the total number of employees, current salaries, bonuses paid during the past 3 years, and years of service. HR policies regarding employee leaves, employee problems and grievances like wrongful termination, sexual harassment, discrimination, legal cases against current or former employees, any financial impact of such labour cases, employee health benefits, and insurance policies are also taken into account.
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Environmental
A company is expected to follow all major environment-related laws, so environmental audits are carried out on the properties owned or leased by the companies. Environmental due diligence is a major assessment issue. The following documents are required for this evaluation:
- All environmental permits, licenses, and validations
- Copies of notices and orders set by environmental protection agency (state) and local regulatory agencies.
It is also checked whether the company is precisely following the current rules and regulations regarding environmental protection.
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Tax
Under this, the documents of tax liability, payment of taxes by the company, and their proper calculations are looked into. The status of any tax-related pending cases too is confirmed with the tax authorities, and documents of tax compliance and verification too are included.
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Intellectual Property
Intellectual property (IP) is one of the company’s most valuable assets since they can use it to monetise their business. Under this due diligence, forms and documents related to copyright, trademark and brand names, patents and patent applications, any pending documents required to be cleared, and any pending cases regarding violation of intellectual property by or against the company have reviewed the findings documented.
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Legal
It is a must. Under this, the following are examined and reviewed
- Copy of Memorandum and Article of Association
- Minutes of shareholder meetings (past 3 years)
- Minutes of Board meetings with an attendance sheet and notices (past 3 years)
- Copy of share certificates
- Copies of guarantees to which the company is a party
- Licensing or franchise agreements
- All the material contracts and loan agreements
Customer’s Due Diligence
This gives a close insight into the target company’s customer base. Under this, a list of top customer companies and of all the customers with their assets, service-related agreements and insurance policies covering assets and capitals, current credit policies, customer satisfaction points, and related reports (past 3 years), a list of customers lost (within 3 to 5 years) are closely examined.
Conclusion
Concluding, Process of due diligence is critical in any situation where you are considering entering into a business relationship with another party. By taking the time to fully understand the other party and their business, you can help protect yourself from risks and make sure that you are entering into a sound business deal.
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