CONDUCT OF A DUE DILIGENCE EXERCISE

Due Diligence exercise is critical to the shaping of a business transaction. A due diligence exercise may be conducted by the Buyer Side, the Seller Side, or there can be independent compliance checks by an organization.

Understanding the Business Transaction

The aim of understanding the business transaction helps formulate the steps, nature, and scope of the due diligence exercise. This further provides the size and scale for conducting the due diligence exercise as well as the jurisdictions within the decided scope. This is imperative because if the due diligence extends to multiple jurisdictions, that would expand the scale of the due diligence exercise as there would multiple local laws and their interactions (Bilateral Investment Treaty, International Investment Dispute Resolution Mechanisms, etc.) to take care while performing the due diligence exercise.

The key to undertanding a business transaction for a due diligence exercise is to look at it from a business perspective first and then a legal perspective.

Using a Checklist

A checklist is a detailed document covering all aspects of due diligence to be covered. It ensures that continuous written records are maintained, and whenever a document/issue mentioned in the checklist is covered, it would be recorded and notes and observations would be made that will be used in the Report Drafting and Presentation of the Due Diligence Exercise. The broad category of issues to be covered are Antitrust and Regulatory Issues, Information Technology Issues, Litigation Issues, Insurance, Tax & Financial Issues, Product/Service & Customer Information, Real Estate & Environmental Issues, Human Resources, and Organisation Goodwill.

Counter-Party Communication

Once the checklist is done, we would know the information required to conduct the due diligence exercise. This would then be used to make the IRL(Information Request List) from the counter-party. It is important to have confirmation on information from the counter-party as far as feasible, other than the authenticity of the information, it also shifts the burden in case of any later issues.

It is imperative to note that counter-party communication has to be handled sensitively. Points of contact need to be established on the basis of access to information, every employee does not have access /knowledge of all aspects of communication, and hence only designated persons should be contacted.

For sensitive information, data rooms are set up.

Data Room Communication

Data Room is a virtual room set up by the counter-party for access to sensitive information that the due diligence team can access through a server. Since access is limited and restricted to the data room, it is important to secure permissions to relevant information. Since the data is sensitive, access is to be provided on a need-to-know basis only.

The first thing when accessing the data room is to understand the Index. The Index of the data room is indicative of the information contained, go through the Index, and highlight any missing areas. It is better to have exhaustive access rather than restricted access where things might be missed out.

Since there are access restrictions, it is important that no member of the due diligence team commits a technological overpass/data breach. Stringent Non-Disclosure & Confidentiality Agreements need to be signed and access rights need to be honored. Furthermore, data rooms are equipped with tracking and backtracing software, therefore it's important to be diligent and use the documents judiciously.

Also, data rooms are mostly access-only, the information isn't downloadable. In such a case, the information has to be accessed meticulously and copious notes need to be maintained. Also, access to the data room is one-time only, so utmost care needs to be taken. If any data needs to be revisited, access would have to be requested again which would hamper the timeline of the due diligence exercise.

The information in Data Rooms is constantly updated and this is communicated through trigger emails. Hence it is imperative to keep track of trigger emails so that if any previously accessed information should be revisited and re-analyzed.

Escalation Matrix

To ensure better conduct of the due diligence exercise, the escalation matrix needs to be used. This provides for two-level analysis of each issue. In the first step, each issue is highlighted and then properly filtered. An additional level of review is preferable, mostly from the team leader. This filters out the material and transactional issues from non-onsequential ones keeping the scope of the due diligence exercise focused on relevance.

Record Keeping: During and Post Due Diligence

Given the magnanimous scope of the information to be analyzed as part of a due diligence exercise, it is imperative that there is meticulous record-keeping of documents reviewed along with the details of the person who accessed the information and the person who analyzed it. This ensures that if the report, information or any part of it needs to be

There should also be an agreement about the period of record preservation post the due diligence exercise has been completed. It is also important to make it clear that the DD team is under no obligation to update the information/due diligence report unless it is explicitly clear with the client. Ensuring security and confidentiality of these records is paramount. It is also wise to preserve contact members of the DD Team to facilitate any post communication.

Also, the records should be systematically preserved to enable retrieval as and when required.

Report Drafting and Presentation

Every due diligence report should strictly adhere to the report format prescribed for that due diligence exercise. The report should have the executive summary followed by the main issues. While drafting the report, it's important to keep observations precise and decision-oriented. It is also better to avoid data overload and supplement that with including more observations and analysis on any potential questions that might arise during the report presentation.

Another key component of the report is to harmonize findings with other parallel teams performing due diligence on the same business transaction. This needs to be accompanied by course-correction measures for potential issues. This increases the potential of the due diligence exercise and makes it more useful to the client in decision making.

Key issues to be included in the due diligence report: pre-transaction & post transaction remediation along with the need for transaction restructuring if necessary, negotiation points and commercial override on the basis of the outcome of the due diligence exercise; potential deal-breakers; impact on the valuation of the business transaction; and additional responsibilities and costs.

The Due Diligence Report is presented by the team leader supported by the DD team for any specifics. The presentation should include an outline of the scope of the DD exercise followed by the analysis and the final outcome directed at how it would affect the business transaction in focus. Special mention has to be made for the accesses not allowed, limitations to data and sample size, important disclaimers. It is also to be made clear that due diligence is a general exercise and not a fraud investigation/ full audit mechanism. It is to be concluded with the affirmation that the report is to the best of the information and data analysed and that there are no certain assurances to any party.