Types of Due Diligence Services and Benefits

Ashish M. Shaji

15 Jan, 2021

A proper Due Diligence (DD) is required to reveal misrepresentation and any sort of fraudulent dealings in major business transactions. In this article we shall discuss about the meaning of Due Diligence Services, its types and benefits.

Meaning of Due Diligence (DD)

Due Diligence services refer to the inspection and risk assessment of an upcoming business transaction. It ensures that the parties to the transaction have the necessary information so that they may proceed with the transaction.

DD is a process of research and analysis that is done before an acquisition, investment etc to determine the value of the main subject or if there is any issue involved. It assesses the financial viability of the entity in terms of its assets and liabilities at comprehensive level.

Objective of Due Diligence

The main objective of conducting DD-

• Collecting material from the target company;
• To improve bargaining position based on SWOT analysis^[1];
• Identifying areas where representations and warranties are needed; and
• To bridge the gap between existing and expected.

Transactions covered for DD

• Mergers and Acquisitions

DD is done with the point of view of the seller and buyer. The buyer looks to the financials, litigation and the range of relevant information. In the case of seller, he focuses on the buyer’s background, financial capabilities and the abilities to fulfil the commitments made.

• Partnership

DD is done for strategic alliances, partnerships, business coalitions and other alike partnerships.

• Joint venture and collaborations

When a company join hands with other, the reputation becomes important. Assuming the stand of other company include the adequacy of supplies at their end.

• Public offer

Aspects that are included during making public offer are decisions on public issues, prospectus disclosures and such other matters.

Types of Due Diligence

Following are the types of Due Diligence services:

Business DD-

It includes looking into parties involved in the transaction, prospectus of business and quality of the investment. This form is further divided into following types:

• Operational
• Strategic;
• Technology;
• Environmental;
• Human resource;
• Ethical.

Operational type looks into operational weaknesses, Target Company functioning, economical impact on the Company’s operational efficiency. In case of Strategic type, it is checked if the business or transaction is commercially feasible. The company’s position in a competitive environment is also looked at to gain better results. In case of Technology type, it includes the check on the current level of technology and the existing level of technology and it’s checked if any investment is required in the company. In Environmental type, it’s checked if there is any environmental risk associated with the company. In Human resource type, the aim is to check the issues related to the workforce in the company. In Ethical, the ethical risks involved with the company are calculated. The ethical character and the reputation of the company etc. are managed under this type.

Legal DD-

Legal DD focuses on the legal aspects of the transaction and the other legal related issues. It basically covers inter-corporate transactions and intra-corporate transactions. Different regulatory checklists are part of this along with already existing documentation.

Under Legal type, the following elements are examined:

• Memorandum of Association;
• Minutes of Board Meetings;
• Licensing agreements;
• Loan agreements.

Financial Due Diligence–

In this financial, operational and commercial assumptions are validated. It comes as a huge relief for the acquiring company. Here in accounting policies are reviewed, audit practices, tax compliances are done in detail. It is the main driver behind the cash flows, identifying monetary risks and deal breakers of the transaction.

Benefits of Due Diligence

These services are needed for an entity so that the entity is well conscious of essentials such as:

• Administration and Ownership

Analysis that run the company

• Capitalization

Helps in analyzing how large and volatile is the market and the company. A contrastive analysis of both is required.

• Business Competitors and Industries

Compare and research the boundaries of the competitors for comprehending the target company.

• Review of balance sheet

It helps in interpreting the debt to equity ratio.

• Analyzing Risks

It helps in learning the industry wide and company specific dangers and check if there are any on-going risks. It predicts any futuristic unforeseeable threats in the near future.

• Expectations

Helps in maximizing the future profit.

• Accuracy

Accuracy of warranties and representations are insured.

• Visionary

Helps in analyzing the big picture of the vision of the target company and its prospects of earnings.

• Transition

Smooth transition of the merger.

Challenges of DD

It gives the acquiring company a superficial understanding of the target company. Due to this business may not succeed all the time. The workforce, work culture etc. remain to be a mystery to the acquiring company which is essential for smooth running. As you would know that this process is judgement driven and therefore it can pose a risk. Availability of information is one of the challenges due to which the process is not so smooth. The confidential nature of the transactions also proves to be an impediment.

How to get the best results from DD?

The following considerations can be taken into account for best results:

• Define the objective and make clear and firm strategies;
• Lay down the terms of reference for every group and draft procedures for allocation of responsibilities;
• Observe integrated approach for this process and rely on the technical expertise of consultants if needed;
• Deploy the use of appropriate technology for collecting, analysing and retrieving data;
• Never hesitate to ask clarifications or queries if there is any;
• Insist on plant visits;
•  The process of DD should be continued until after the completion of the transaction.

Conclusion

Read our article:Summarizing the Due Diligence Process in India