Due Diligence

Due Diligence in India-Process, Type and Categories

Foreign companies planning to invest in India should perform a due diligence check. It helps identify or prepare against any possible exposure to risk. Assessment is carried out in various scenarios, such as mergers and acquisitions, partnerships, joint ventures, and IPOs. Assessment is carried out to ensure adherence to distinct legal and regulatory compliance requirements. Due Diligence is important to avoid bad transactions, identify issues within the company, and verify the background of the business.

Meaning of Due Diligence

Due Diligence is the exercise of reasonable care in the course of a business. Assessment means the careful examination of various aspects of a business. These aspects include economic, legal, fiscal, and financial. It also covers investigating sales figures, shareholder structure, and possible links forming economic crime like corruption and tax evasion. Due Diligence is necessary to perform risk and compliance checks and protect themselves. Assessment involves risk and compliance checks, conducting investigations, and reviewing and auditing data about a particular subject.

Who carries our Due Diligence?

Due diligence is carried out by equity research firms, individual investors, fund managers, risk and compliance analysts, firms, and broker-dealers. Individual investors can also conduct their own assessments. Broker-dealers can conduct an assessment of a security before selling it.

What are the documents required for conducting due diligence?

1. Information about the Company
2. Financial Statements
3. Business Agreements
4. Intellectual Property Rights details
5. Litigation Aspects
6. Taxation¹ Aspects
7. Human Resource Aspects
8. Cultural Aspects
9. Insurance Aspects
10. Environmental Aspects
11. Marketing Information
12. Internal Control check system

Types of Due Diligence

Administrative Due Diligence

Administrative Due Diligence involves verifying related administrative things such as facilities provided, number of people employed, rate of occupancy, etc. This type of assessment is required to keep a check on various facilities owned or occupied by the seller, and a check of the finance department captures all operational costs. Conducting this type of assessment gives a clear picture of the Buyer’s cost, which may have been incurred if they plan to expand the target company further.

Financial Due Diligence

In financial due diligence, it is checked whether the financials in the Confidentiality Information Memorandum (CIM) are accurate or not. The aim is to understand all of the Company’s financials, including the following:

1. Audited financial statements of the previous three years
2. Un-audited financial statements
3. The Company’s projections and the basis of such projections
4. Capital expenditure plan
5. Schedule of inventory
6. Debtors and creditors, etc
7. Analysis of major customer accounts
8. Fixed and variable cost analysis
9. Analysis of profit margins
10. Examination of internal control procedures
11. Company’s order book and sales pipeline to create better projections

Asset Due Diligence

This type of assessment involves a detailed investigation of the schedule of fixed assets and their locations physically and on paper; it consists of the following:

1. All lease agreements for equipment
2. All sales and purchases of significant capital equipment
3. Real estate deeds
4. Mortgages
5. Title policies and
6. Use permits.

Human Resource Due Diligence

This type of Due Diligence is very extensive. It involves numerous labour laws and policies. It consists of the following:

1. Analysis of the total number of employees, their current positions, number of vacancies, the retirement due of the employees, and the period of serving notice.
2. Analysis of current salaries of all employees, including employees on a contractual basis, bonuses paid to the employees during the last three years, and the years of service of the employees.
3. Employment contracts with non-disclosure, non-solicitation clauses, and non-competitive agreements between the Company and its employees.
4. HR policies include sick, annual, and other forms of leave the Company allows.
5. Looking into employee problems such as wrongful termination, sexual harassment, and discrimination between co-workers, and an examination of any legal cases pending with the current or former employees.
6. The potential financial impact of any ongoing labour case, arbitration proceedings or any grievance on the procedures.
7. Employees’ Health Benefits along with their insurance policies, if any.
8. ESOPs and Schedule of Grants.

Environmental Due Diligence

In the present-day scenario, an environment check is required. Every Company is required to adhere to the environmental laws. In case of failure to comply with the environment-related laws, the local authorities have the power to impose a penalty on the Company or order to cease all its operations. Thus, an environmental audit is important for each company-owned or leased property. While conducting environmental due diligence, the following points should be evaluated:

1. All the list of environmental permits, licenses and validation.
2. Copies of all notices and orders with the Environment Protection Agency, state and local regulatory agencies.
3. Check if the Company complies with the current rules and regulations.
4. Look into all the contingent environmental liabilities or continuing indemnification obligations that are required to be fulfilled.

Tax Due Diligence

This type of tax due diligence refers to scrutinising all the documents about the company’s tax liability and taxes and ensuring that tax is calculated correctly. Further, the status of tax-related pending cases is also checked with the tax authorities. Tax assessment includes verification of the following points:

1. Copies of all tax returns, such as income and sales taxes, for the past three to five years.
2. All necessary information pertaining to the Company’s past or pending tax audits.
3. Documentation relating to Net Operating loss or any unused credit carryforwards of deductions or tax credits.
4. Any critical, out-of-the-ordinary correspondence with tax agencies.

Intellectual Property Due Diligence

IP is an intangible business asset that is an integral part of the business. Intangible assets are something that differentiates a product and service from its competitors. It sometimes comprises of Company’s most valuable asset. What is to be looked at while conducting intellectual property due diligence are:

1. Forms and related documents for copyrights, trademarks and brand names
2. Forms and related documents for patents and patent applications
3. Any pending documents which are required to be cleared
4. Any pending actionable or not actionable claims case by or against the Company regarding violation of intellectual property.

Legal Due Diligence

Legal, due diligence includes the examination and review of the following:

1. Copy of Memorandum and Articles of Association
2. Minutes of all the shareholder meetings over the previous three years
3. Minutes of Board Meetings, along with attendance sheets and notices of the last three years of the Company
4. Copy of share certificate issued to key management personnel along with share transfer forms
5. Copies of all kinds of guarantees to which the Company is a party
6. Licensing or franchise agreements
7. All the material contracts, which include any joint venture, partnership agreement, limited liability company or operating agreements
8. Copies of all loan agreements, related bank financial agreements and all lines of credit of a company.

 Customer Due Diligence

This Analysis includes having a closer look at the target company and its customer base. The following points are analyzed and examined in this process:

1. List of the Company’s top customers, like the largest and total number of purchases from the Company, and list of all customers along with their assets.
2. Service-related agreements and insurance policies covering assets and capitals
3. Current credit policies which review the day’s sales outstanding metric to assess the efficiency of accounts receivable
4. Customer satisfaction points and related reports for the past three years
5. List and explain any significant customers lost within the past three to five years.

Conclusion

There is no specific law on Due Diligence. However, it is a crucial step. It requires a company to know the health of the Company it is investing in. Legal professionals usually carry out the process.

FAQs

1. https://incometaxindia.gov.in/Pages/default.aspx