It is the process by which confidential legal, financial and other material information is exchanged, reviewed and appraised by the parties to a business transaction, which is done prior to the transaction. “Due diligence” is an analysis and risk assessment of an impending business transaction. It is the careful and methodological investigation of a business or persons, or the performance of an act with a certain standard of care to ensure that information is accurate, and to uncover information that may affect the outcome of the transaction. It is basically a “background check” to make sure that the parties to the transaction have the required information they need, to proceed with the transaction. Due diligence is used to investigate and evaluate a business opportunity. The term due diligence describes a general duty to exercise care in any transaction. As such, it spans investigation into all relevant aspects of the past, present, and predictable future of the business of a target company. Due diligence report should provide information and insight on aspects such as the risks of a transaction, the value at which a transaction should be undertaken, the warranties and indemnities that needs to be obtained from the vendor etc.

Due diligence is generally understood by the legal, financial and business communities/potential investors to mean the disclosure and assimilation of public and proprietary information related to the assets and liabilities of the business being acquired.

This information includes financial, human resources, tax, environmental, legal matters, intellectual property matters etc. Due diligence would include thorough understanding of all the obligations of the target company: debts, rights and obligations, pending and potential lawsuits, leases, warranties, all high and impact laden contracts – both inter-corporate and intra-corporate. The investigation or inspection would cover: — Compliance with applicable laws — Regulatory violations or disciplinary actions — Litigation and assessment of feasibility of pursuing litigation — Financial statements — Assets – real and intellectual property, brand value etc. — Unpaid tax liens and/or judgements — Past business failures and consequential debt — Exaggerated credentials/Fraudulent claims — Misrepresentations or character issues — Cross-border issues – double taxation, foreign exchange fluctuation, sovereign risk, investment climate, cultural aspects. — Reputation, goodwill and other intangible assets.

Types of Due Diligence In business transactions, the due diligence process varies for different types of companies.

The relevant areas of concern may include the financial, legal, labour, tax, environment and market/commercial situation of the company.

Other areas include intellectual property, real and personal property, insurance and liability coverage, debt instrument review, employee benefits and labour matters, immigration, and international transactions.

The most important types of Due Diligence are:

A. Business Due Diligence

  • (i) Operational due diligence
  • (ii) Strategic due diligence
  • (iii) Technical due diligence
  • (iv) Environmental due diligence
  • (v) Human Resource Due diligence
  • (vi) Information Security due diligence
  • (vii) Ethical Due Diligence

B. Legal Due Diligence (including secretarial due diligence)

C. Financial Due Diligence (including tax due diligence).

A. Business Due Diligence Business due diligence involves looking at quality of parties to a transaction, business prospects and quality .It involves,

  • (i) Operational due diligence Operational due diligence aims at the assessment of the functional operations of the target company, connectivity between operations, technological upgradation in operational process, financial impact on operational efficiency etc. It also uncovers aspects on operational weakness, inadequacy of control mechanisms etc.
  • (ii) Strategic due diligence Strategic due diligence tests the strategic rationale behind a proposed transaction and analyses whether the deal is commercially viable, whether the targeted value would be realized. It considers factors such as value creation opportunities, competitive position, critical capabilities.
  • (iii) Technical Due Diligence Technical due diligence covers— (a) intellectual property due diligence; and (b) technology due diligence. (a) Intellectual Property due diligence The recent concept of valuation of intangible assets related to Intellectual Property like Patents, Copyrights, Design, Trademarks, Brands etc., also getting greater importance as these Intellectual Properties of the business are now often sold and purchased in the market by itself, like any other tangible asset. Many Indian companies and corporate entities however do not give much importance to the portfolio management of their Intellectual Property Rights (IPR).
    The main objective of intellectual property due diligence is to ascertain the nature and scope of target company’s right over the intellectual property, to evaluate the validity of the same and to ensure whether there is no infringement claims. (b) Technology due diligence Technology due diligence considers aspects such as current level of technology, company’s existing technology, further investments required etc. Technology is a key component of merger and acquisition activities; it’s imperative to look at IT considerations.
  • (iv) Environmental Due Diligence Environmental due diligence analyses environmental risks and liabilities associated with an organisation. This investigation is usually undertaken before a merger, acquisition, management buy-out, corporate restructure etc. Environmental due diligence provides the acquirer with a detailed assessment of the historic, current and potential future environmental risks associated with the target organisation’s sites and operations. It involves risk identification and assessment with respect to: (a) review the environmental setting and history of the site (b) assessment of the site conditions (c) operations and management of sites (d) confirm legal compliance and pollution checks from regulatory authorities etc
  • (v) Human Resource Due Diligence Human Resource Due Diligence aims at people or related issues. Key managers and scarce talent leave unexpectedly. Valuable operating synergies gets disturbed, when cultural differences between companies aren’t understood or are simply ignored. It’s crucial to consider cultural and employees issues upfront, for success of any venture.
  • (vi) Information Security Due Diligence Information security due diligence is often undertaken during the information technology procurement process to ensure that risks are uncovered.
  • (vii) Ethical Due Diligence Ethical Due Diligence measures ethical character of the company and identify the possibilities of ethical risks, which is a non-financial risk. It may relate to reputation, governance, ethical values etc. It helps an organization to decide whether the partner is ethically viable. This is an effective reputation management tool for any type of business decisions.

B. Legal Due Diligence A legal due diligence covers the legal aspects of a business transaction, liabilities of the target company, potential legal pitfalls and other related issues.

  • Legal due diligence covers intra-corporate and intercorporate transactions.
  • It includes preparation of regulatory checklists meeting with personnel, independent check with regulatory authorities etc. apart from document verification.

C. Financial Due Diligence Financial due diligence provides peace of mind to both corporate and financial buyers, by analysing and validating all the financial, commercial, operational and strategic assumptions being made.

Financial Due Diligence includes review of accounting policies, review of internal audit procedures, quality and sustainability of earnings and cash flow, condition and value of assets, potential liabilities, tax implications of deal structures, examination of information systems to establish the reliability of financial information, internal control systems etc.

The tax due diligence comprises an analysis of: — tax compliance — tax contingencies and aggressive positions — transfer pricing — identification of risk areas — tax planning and opportunities

We undertake legal, financial as well as technological due diligence that involves:

  • Legal and secretarial due diligence process in relation to IPOs , FCCB issue, drafting of Prospectus, Letter of Offer and other documents
  • Preferential Issues and Private Placements
  • Research and reviewing
  • Controls testing

Compliance and legal due diligence:

For legal compliance management, we provide service of legal review of all or select applicable laws.

I. Comprehensive legal compliance review exercise

This exercise is aim to provide comprehensive list of applicable laws, finding out personnel responsible for their compliance and to create, update and monitor compliance standards. This exercise is intended to be reviewed once in 2/3 years, depending upon size and need of the organisation.

Briefly, the following procedure is followed::

  • (i) finding out applicable laws, with our team and team of Clients
  • (ii) to collate statutes (Acts, Ordinance, Rules, Regulations, Circulars, Notifications and in some cases relevant court rulings);
  • (iii) Create checklists on all* or select applicable laws as agreed with clients
  • (iv) Provide updates on all/select applicable laws at agreed intervals
  • (v) To review compliance of all/select applicable laws at agreed intervals and provide report on exceptions (non-compliances), by assigning risk rating.

* Currently covering Companies Act, SEBI Regulations, Listing agreement, SCRA, FEMA, Competition Act, Trade Marks Act, Copyright Act, Shops and Establishments Act, Profession Tax and major Labour Laws.

II. Periodic limited legal compliance review:

This exercise is intended to ensure periodic review of compliance of key important applicable laws. It is carried out as per clients requirements. It can be either for issue of certificate and/or as part of internal control and legal risk management.

Review of compliance of conditions of Corporate Governance as per clause 49 of listing agreement is an example of this exercise.

III. To verify compliance of specific laws as one time exercise:

It can be where a company intends to acquire or sale business/organisation. Or it can be upon receipt of some notice or for tightening loose ends of compliances for example review of compliances of the SEBI (Prohibition of Insider Trading) Regulations 1992 and under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 1997.

As periodic limited legal compliance review is intended for independence view, it is not substitute to internal mechanism to ensure compliance of applicable laws.

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