DUE DILIGENCE

Due Diligence

Due Diligence is a very common and popular term in the corporate world in relation to corporate restructuring, merger & acquisition, joint venture, spin-offs, amalgamations etc. Due diligence is one of the key elements in all these types of transactions because of the fact that the transactions are being done between two unrelated parties, who don’t have a depth understanding about the business which they are going to take over or merge with. Due diligence may also be required to be done in case of venture capital financing, lending, public offerings, disinvestment etc.

Purpose of Due Diligence

The purpose of due diligence exercise is to assist the purchaser or the investor in finding out all the facts and figures (including its critical success factors, its strengths and weaknesses) about the business he is going to acquire or invest prior to completion of the transaction.

Classification of Due Diligence

Commercial or operational due diligence: it is generally performed by the concerned acquirer enterprise and involves an evaluation from a commercial, strategic or operational perspective. For example, whether the proposed merger would create operational synergies.

Financial due diligence: the role of financial due diligence commences after a price has been agreed for the business. The principal objective of financial due diligence is usually to look behind the veil of initial information provided by the company and to assess the benefits and costs of the proposed acquisition/merger by inquiring into all relevant aspects of the past, present and future of the business to be acquired/merged with.

Tax due diligence: generally, tax due diligence is conducted by the tax authorities or on their behalf by any professional to ensure whether the company is adhering the tax provisions or not.

Information system due diligence: to assess the accuracy and completeness of Information systems of the company.

Legal due diligence: to ensure that the company is complying with the legal provisions or not. For example, whether the company is filing annual returns or not, whether necessary board resolutions are being passed or not, whether the minutes book is being maintained and updated or not.

Effect of due diligence on valuation

In today’s complex business situations, due diligence is a necessity for measuring the magnitude of risk associated with a business.

The value of the business depends on the assets and liabilities, which are in possession of the company. To enhance the value of the business, management of the company may have overvalued the assets or there may be some hidden liabilities of the business. The objective of due diligence process is to look specifically for any hidden liabilities or overvalued assets.