The term “due diligence” is not defined in Indian law, but it suggests that a buyer should exercise caution. It is an inquiry or verification of the affairs of a business organization conducted by any individual or other business entity interested in taking over, combining, or investing in that former entity. This is done to prevent foreseeable risks. Every business must conduct legal due diligence and be ready for unwelcome surprises before doing any deal into the mergers & acquisitions. There are many processes involved in due diligence including business due diligence, special due diligence, accounting due diligence, and legal due diligence. Due diligence looks at the past and current performances of the businesses.
LIMITED VS. EXHAUSTIVE DUE DILIGENCE
As we talk about limited due diligence, we imply it’s confined to a certain level and focused on certain legal concerns, whereas exhaustive due diligence takes into account, encompasses, and evaluates everything about a corporate organization. While considering a merger or an acquisition transaction, the buyer, acquirer, or investor, as the case may be, will have limited knowledge pertaining to the target company other than what is available in the public domain.
Due to this, the buyer will appoint legal and financial experts preferably lawyers, chartered accountants, or merchant bankers to conduct an exhaustive due diligence process on its behalf. In an exhaustive due diligence process, a vast amount of information is to be reviewed. The legal due diligence team typically analyses the charter documents, material contracts, employment agreements, and real estate documents. Including corporate compliances, tax compliances, financial documents, insurance contracts, labor law compliances, intellectual property rights, and any litigation proceedings by & against the target company.
Prospective buyers should gather documentation that reveals the company’s organization the parties need to refrain from the structure. They must also gather information on taxes, strategic fit, intellectual property, material assets, contracts, members, and lawsuits.
PROS AND CONS
- It aids in the identification and mitigation of the target entity’s risks and responsibilities.
- It evaluates the value of the target entity.
- The information acquired following due diligence aids in deciding whether or not the agreement with the target firm is worthwhile.
- Exhaustive due diligence helps in getting complete or overall information about the target entity.
- Limited information or inquiry is the main reason for mergers & acquisitions failure.
- Exhaustive due diligence is a very time-consuming process.
- Any mistake, omission, or oversight committed at the time of the due diligence process can have adverse effects.
IMPACTS ON INDUSTRY
- When a business entity confirms a deal without doing due diligence or deal on insufficient due diligence, the damages can be dangerous.
- After merger or acquisition, all financial risks of the target company are transferred to the acquirer company.
- Once governmental authorities or third parties take action against a targeted firm following a merger or purchase, the acquirer will face substantial legal fights and proceedings even if the acquirer had no involvement in the targeted firm’s non-compliance, fraud, or irregularity. Therefore, strict due diligence and deep investigation into the background of the cases of the targeted company are of paramount importance.
A well-executed due diligence process with proper effort is an essential part of a successful M&A deal. Negligence or other improper conduct in this regard will have harmful effects upon the deal of M&A. A failed M&A deal will create serious financial and legal difficulties and damage the reputation of the parties to the deal.
In order to remove any inadequacies in a due diligence process, it is essential that the process is done by people with the necessary skills and competencies. A well-qualified team with a systematic approach will make sure that the risks associated with the deal are identified and are not transmitted to the consumer.
Therefore, it is essential for the parties to refrain from being overly enthusiastic or emotionally vested in a transaction that can cause the parties to ignore any negative information and cloud their judgment. The next time you engage in an M&A transaction, you’ll know what to do and how to go with your legal due diligence process, which will provide you with a clear picture of your future with the subject firm.