Due Diligence is combined result of Audit, Investigation, Review, Verification and Valuation of an object (assets, shares or any other investment). The Due diligence means “the care that a reasonable person exercises to avoid harm to other persons or their property.” In other words “Due Diligence is an extensive process of validations of available records to identify the potential risk. We can say that Due Diligence is outcome of process of research carried out with intent to take proposed decision regarding acquiring an object and such object can be a Company, New investment etc.
What is objective of Due Diligence
The core objective of Due Diligence is to conclude a decision. The Due Diligence plays a crucial role in decision making whether object in consideration is profitable to acquire or not. One of the key objectives of due diligence is to minimize, to the maximum extent practicable, the possibility of there being unknown liabilities or risks. Following the list of true objective of Due Diligence:
- Identify potential risk
- Identify the True Value of object
- Protect the value of proposed assets
- Feasibility analysis of target
- Compliance assurance and reporting of non-compliance
- Determination of Contingent liability
- Acquire information of target/object
- Analysis and Understand capabilities of management of target/object
- Understanding of tax implication and resolution thereof
Types of Due Diligence
There are various kinds of Due Diligence which can be performed depending upon the type of object. Here is list of all possible types of Due Diligence:
1) Financial Due Diligence
This is one of most demanded Due Diligence. Financial due diligence provides peace of mind to acquiree, by analysing and validating all the financial, commercial, operational and strategic assumptions being made. Due Diligence aims to provide a thorough understanding of all the company’s financials, including, but not restricted to, audited financial statements for the last three year to five years, recent unaudited financial statements with comparable statements of the last year, the company’s projections and the basis of such projections, capital expenditure plan, schedule of inventory, debtors and creditors, etc. This is the kind of due diligence focus on profitability of targets whether object will provide expected profit or not. Financial due diligence provides the expected period of time under which investment amount can be recovered.
2) Business Due Diligence or Operational Due Diligence
This kind of Due Diligence walks around business activities like products, customer, machinery etc. It is basically evaluation of operational feasibility. This investigates all of the company’s procedures, its locations, inventories, suppliers, management structure, staff levels and skills, customer relations etc. It’s typically analysis of sales trend, product demands, customer’s feedback and product quality. This kind of Due Diligence walks around business activities like products, customer, machinery etc. It is basically evaluation of operational feasibility. This investigates all of the company’s procedures, its locations, inventories, suppliers, management structure, staff levels and skills, customer relations etc. It’s typically analysis of sales trend, product demands, customer’s feedback and product quality.
3) Legal Due Diligence
It is most important form of Due Diligence. It involves analyzing and understanding the legal risk associated with the target company before a merger or an acquisitions transaction. It helps the acquirer to understand the target’s corporate and legal structure. It covers all the ongoing litigations proceedings and estimates the expected outcome. The key object of legal due diligence is to check legal feasibility of proposed deal whether there any legal hurdles which may impose some restrictions in completion of deal. A legal due diligence is typically completed by an attorney who specializes in due diligence investigations. The lawyer or lawyers prepares a legal opinion based upon information gathered during execution of work.
4) Apart from above said three type of Due Diligence there are other various types of Due Diligence which are basically sub categorisation of above analysed due diligence which are as follows:
- Human Recourse Due Diligence
- Administrative Due Diligence
- Environmental Due Diligence
Area in which Due Diligence is required
Following are the Key Area in which Due Diligence can be carried out :
- Merger and Acquisition
- Purchase of share in bulk quantity
- Joint Venture
- Initial Public offering
- Entering into new Partnership
Steps involved in Due Diligence
This is the first phase of Due Diligence. The Due Diligence starts with planning of what to do, how to do and when to do. Under this phase of Due Diligence, the person (Consultant) who is responsible for Due Diligence meets with acquirer and acquiree and frames the strategy, fixed the milestones and responsibility between various person who will be in execution of Due Diligence.
This is most important phase of Due Diligence. Under this stage, Consultant start performing the functions as per planning done under phase one of Due Diligence. This phase start with acquisition and gathering of data from various sources including public domains like Ministry of Corporate affairs, Central Board of Custom and Indirect taxes, Central Bank etc. After gathering of data, consultant starts validation of data and performs their procedure on said data. After comprehensive analysis of data consultant prepares their conclusion.
This is smallest phase of Due Diligence and under this step, consultant verifies the information obtained form acquiree with data available in independent public domain. It is basically cross check of data provided by acquiree with independent source.
4) Preparation of Report
It is last phase of Due Diligence. Under this phase consultant combined the results obtain in previous phase and convert these results in form of report. Such reports in basically conclusion of findings of consultant and their view on proposed deal. Through this reports, consultant provides their feedback about whether it will be fruitful to enter in proposed deal or not.