Basic Aspects of Due Diligence

Due Diligence is an exercise undertaken by Corporate Entities before entering into major transactions such as mergers and acquisitions, issuing new stock or other securities, project finance, etc to minimize risk and liabilities and maximize their assets.

Scope of the Due Diligence Exercise

Determination of the scope of the due diligence exercise depends on the nature of the business transaction, size & purview as well as the jurisdiction. The focus has to be on the period/sample size of the due diligence decided by category, location, factory. It's a common misconception that a due diligence exercise is all-encompassing which isn't pragmatically feasible. Hence the focus areas, transaction drivers, materiality threshold values, liability(both civil and criminal) as well as the exclusions and inclusions all form the scope of the due diligence exercise. These variables need to be pre-decided before undertaking the due diligence exercise and periodically revisited as the exercise happens.

Other decisions include whether the due diligence exercise would be remote or would be in-situ involving site-visits which is contingent on the permitted time-line, fees involved, and the resource estimation. The potential of the due diligence Exercise also depends upon identification and access of the applicable laws including notifications, circulars, orders, recent judgments, and other daily updates.

Language can also be a barrier while pursuing a due diligence exercise as the relevant documents, property deeds and others would be in the local language and care has to be taken that key details are not missed in interpretation/translation. Care is also to be taken about access to documents/data room as well as interdependence with other teams. Accounts, Finance, HR, and Legal would have different core competencies that should cooperate together to fulfill due diligence exercise.

It is imperative to note here that substantial information has to come from the counter-party. There's a separate list on do's and don'ts to keep in mind here.

Resources for Due Diligence Exercise

The most important step with the execution of any due diligence exercise is to collect all the information pertinent within the scope, comprehend, and then compile the report that would be beneficial to the client.

While every due diligence is different in its scope and execution, a common resource used is a checklist. Every checklist is unique to the particular transaction, and different lists are created according to the nature and timeline of the transaction. For example, for a legal due diligence exercise, the checklist would include contracts, IPR, Labour laws, a list of all applicable laws including local laws, etc.

Checklists can make use of IRL to supplement in order to make it more exhaustive. The purpose of IRL(Information Request List) is to enable the collection of financial, corporate, and other relevant information from the counterparty to facilitate the due diligence exercise.

The second important resource is Industry Research. This would cover two key aspects, one being core industry research that is tailor-made to the specifications of the transaction/organization as well as would include peer research in the industry in similar transactions. This allows regulatory/labour issues to be perused that could be missed if we kept a narrow view of just that particular transaction and organization. The second aspect here is google research. This is important because this highlights the inward-looking issues that can be missed by the organizational/transactional research like environmental or background points.

The third important resource is access to Corporate Documents. These documents would include Balance Sheet, Auditor's Report, Key Certifications, Directors Report, Auditors Report along with other transaction-specific documents. This would also include access to counterparty opinions, resources, and documentation which also facilitates the making of the Information Resource List.

The fourth important resource is the Identification of Special Areas of Law. This is a separate category because this derives from prior/industry experience of similar/different organizations/transactions as well as contemporary issues. This would identify issues regarding labour laws, parallel environmental concerns, as well as relevant recent judgments.

Team for Due Diligence Exercise

Due Diligence is a multifaceted exercise. It's imperative that the roles and responsibilities are clear for each member including counter-party communication. Since counterparty communications are sensitive and time-bound, care has to be taken. The members need to be trained and professionally equipped with adequate relevant resources so that they can get the information right in just one attempt because there's limited access to revisit the site or get access to the data room again.

Since the team performing the due diligence exercise has access to sensitive information regarding pricing as well as customer information and counter-party competition law claims may arise, it's imperative that utmost independence and confidentiality are exercised. The teams need to be formulated in such a way that information is not shared between parties and there are exclusive members to handle different aspects of this.

To ensure successful completion of the due diligence exercise, it's important that expectations are set with proper timelines, there are constant monitoring and supervision as well as an efficient communication channel to discuss relevant issues and resolve problems.

Outcome and Impact of Due Diligence Exercise

Due Diligence exercise must be conducted through the perspective of the Client. The outcome expected, i.e. the decision to be made from the result of the due diligence exercise should be the premise for the final report. This has to be kept in perspective from start to finish of the due diligence exercise. Decisions regarding transactional drivers, key issues to be covered, the sample size for the focus group need to be prioritized according to the expected outcome.

While identifying issues during the due diligence exercise, the focus needs to be on research and analysis of the implications, solution, and key concerns which is form the material information for the business transaction for which the due diligence exercise is being conducted. The issues need to be categorized as high, medium, and low impact issues and dealt accordingly in the final report.

The outcome should also account for related party transactions as well as any conflicts of interest that might arise and they need to be highlighted. Most imperatively, the due diligence exercise needs to look beyond the ordinary, for example with COVID-19 and make relevant issues too.

This would determine whether the client wants to move forward with the transaction or on the basis of liability how the transaction needs to be restructured or should it be dropped altogether.

In conclusion, even before the start of the conduct of the due diligence exercise, these relevant factors need to be kept in mind. This would ensure the smooth conduct of the due diligence exercise and also refers to as the guide if at any stage control is required.