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Everything you need to know about Due Diligence

By 05/06/2021June 8th, 2021No Comments

DUE DILIGENCE

Due diligence is a procedure that entails:

  • Estimating an entity’s commercial potential by analyzing various aspects.
  • A comprehensive assessment of the financial viability of an entity based on its assets and liabilities.
  • Reviewing the operations and verifying the material facts of the entity concerning relation to a proposed transaction.

The term ‘due diligence’ refers to the process of verifying and taking steps to detect and avoid anticipated dangers. It is the process of thoroughly assessing a problem from a range of angles before deciding on a business.

The Indian legal, economic, and regulatory environment is complex. Therefore, a company’s ability to navigate the Indian business landscape is critical to its success. Thus, a company’s success is directly related to the risk management and mitigation strategies it employs.

Types

  1.   Operation Due Diligence: Assesses the Target company’s operational efficiency. Examine non-financial components of a Target company, such as system and process evaluations, management team evaluations, personnel levels, and other HR operations, or insurance arrangements.
  2.   Technical Due Diligence: Examines and performs due diligence on intangible assets such as Patents, Copyrights, Designs, Trademarks, and Brands. Furthermore, it includes assessing the Target Company’s performance on the current level of technology and determining future scope for improvement.

Focus areas of Due diligence

  1.     Mergers and Acquisitions: Both the buyer and the seller perform due diligence. The seller is more concerned with the buyer’s background, financial capabilities, and capacity to follow obligations than the buyer, who is concerned with financials, lawsuits, patents, and a wide variety of other pertinent facts.
  2. Financing Agreements: Examine copies of all agreements evidencing borrowings by the Target company, whether secured or unsecured, documented or undocumented, such as loan and credit agreements, mortgages, deeds of trust, letters of credit, indentures, promissory notes, and other shreds of evidence of indebtedness, as well as any amendments, renewals, notices, or waivers, as well as any amendments, renewals, notices, or waivers…[1]
  3.     Partnership: All strategic alliances, strategic partnerships, business coalitions, and other partnerships are subject to due diligence.
  4.     Joint Enterprise and Collaboration: When companies join forces, the reliability of the combined company is a subject of concern. Accordingly, the other company’s position would include the adequacy of supplies at their end.
  5. Intellectual Property: Patents, trademarks, copyrights, and trade secrets are all forms of intellectual property. A thorough examination of all contracts, licenses, and litigations involving a target company’s intellectual property is conducted as part of legal due diligence.
  6.     To check Regulatory Compliance: A compliance with regulations, policies, and standards refers to an organization’s adherence to the laws, regulations, and policies within which it operates. To ensure regulatory compliance, the acquirer must ensure that the target company is on the right side of the law. In this regard, legal due diligence is an essential component of the due diligence process, where the acquirer can view how the target company follows regulatory guidelines and complies with regulations.

Advantages

  •   Opportunity to understand the target company: An acquirer can run due diligence on a target company before closing a deal, identifying and assessing risks, liabilities, and business problems ahead of time, helping to prevent losses and poor press later on.
  •       To identify the future of business: To make informed decisions, the information gathered during this process should be reported. By reviewing the Due Diligence report, one can determine how the company plans to earn additional income (both monetary and non-monetary). As a result, it serves as a handy reference for understanding the state of affairs at the time of purchase/sale, etc. Ultimately, the goal is to get an accurate understanding of how the business will perform.

To identify future Legal risk: There may be risks entrenched inside the target firm that might become troublesome after the merger, in addition to the risks connected with finalizing the acquisition. Furthermore, these risks may include outstanding litigation, permission on pending intellectual property such as patents, trademarks, and other forms of intellectual property, tax and other government responsibilities, and so on.

Limitations

Due diligence provides a superficial understanding of the target company to the acquiring company. Thus, businesses may not succeed at all times as a result.

  1.  Commercial or financial risks: An examination of asset elements including operating and maintenance costs, current and future profitability, the cost of environmental mitigation measures (such as pollution), and the impact of potential delays or problems.
  2. To the acquiring company, the workforce, the competencies, and the work culture remain a mystery, all of which are crucial to its smooth operation.
  3.  There is a risk involved with due diligence because it is judgment-driven.
  4.  There is one major obstacle that often causes the process to be shaky, and that is the lack of available information.

According to independent surveys, countries with higher levels of development have less corruption and greater openness, making it simpler to verify facts. A company conducting due diligence may quickly obtain information from a number of government offices that also serve as public record offices. A factor that is intricately related to the accessibility of information is the efficiency of such offices in keeping information records. The answer depends on the archiving and filing processes these offices follow, as well as the level of information of records they have.

Conclusion

Obtaining accurate and timely feedback on financial facts is the foundation of a strong decision-making process. Due diligence should be considered an essential component of every financial transaction or activity. Due diligence must be organised and coordinated so that the buyer may make an educated choice about whether or not to proceed with the purchase or operation based on the information gathered.

 

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