What is Due diligence?

In order to make an informed decision and obtain desired results from a transaction, it is important to gather information about a target company – its business and environment in which it operates.

There is dire need to mitigate overall transaction risk through the identification, quantification and substantiation of value drivers or value inhibitors, and to recognize the differences, if any, between these and what was the basis of anticipated deal value at the beginning of the process. We assist the client in conducting due diligence before entering into any transaction and assist them in gaining holistic view of the factors including financial, commercial and taxation  that may impact the material business of the entity.

Financial Due Diligence (FDD):

Our experts go beyond the traditional audit and look at business from a commercial perspective. Under Financial Due Diligence, they investigate into the financial affairs that have a material impact on the prospects of the target business. The intent is to identify, quantify and substantiate value drivers or value inhibitors of the proposed transaction.

We do Buy Side as well as Sell Side Due Diligence

Buy Side Due Diligence helps in

  • Providing valuable insight into the operations of the company
  • Structuring and valuing the transaction, Negotiating purchase price and purchase agreements
  • Determining future financing strategies
  • Identifying operational areas upon which to concentrate after the deal closes
  • Assist in determining where the value in the company is and where the “black holes” aree

Some key questions which we help answer for the client are

  • What are the quality of historical earnings and risks in achieving the projections?
  • What are the current and projected WC requirements of the business?
  • What are the risks that the numbers are not right?
  • What is the accuracy of provisions in the balance sheet?
  • What are the off balance sheet liabilities?

Sell Side Financial / Vendor Due Diligence helps

  • Negotiate the best deal
  • Allows greater competition
  • Retain control of negotiation
  • Suited to the process where multiple bidders or investors are involved
  • Meet the timelines
  • No surprises/“black holes”
  • Reduces strain on management
  • Reduces disruption to business operations
  • Minimum post-completion and separation issues

Tax Due Diligence (TDD):

Tax Due Diligence helps in reducing the risk of acquiring unseen tax liabilities and risk exposures associated with such transaction. Tax Due Diligence is important due to the following reasons

  • Identification of any material tax exposures
  • Validating representations made by the seller
  • Validating assumptions in valuation of buyer
  • Structuring deal in a tax efficient manner
  • Identifying tax saving opportunities
  • Understanding the target

Typical direct tax issues which arise in due diligences are

  • Penalty and Interest exposure
  • Withholding tax implications
  • Transfer Pricing implications
  • Tax exposure on account of business reorganization in the past like merger, demerger, capital restructuring, etc
  • Analysis of carry forward of losses after the transaction
  • Analysis of availability of tax holidays after the transaction
  • Analysis of tax positions on deductions and exemptions claimed
  • MAT credit entitlement
  • Tax litigation

Typical Direct Tax issues which arise in Due Diligences are:

Service Tax

  • Non-payment of service tax under reverse charge as a receipient
  • Input service distribution
  • Availment and utilization of CENVAT
  • Services not qualifying as Export
  • Service tax on reimbursements
  • Payments to related parties

VAT/CST

  • Incorrect classification of goods
  • Non deduction of withholding related to Work Contract Tax
  • Incorrect availment of input tax credits
  • Pending Status or lost statutory forms

Excise

  • Incorrect classification of goods
  • Issues in area based exemptions
  • Valuation of supplies to related entities
  • Availment of CENVAT credit in relation to trading and exempted activity

Miscellaneous Issues

  • Imports from related parties without Special Valuation Bench order
  • Issues in availment of benefits under the Foreign Trade Policy and related compliances
  • Non-payment of Entry tax/Octroi/LBT
  • Non fulfillment of incentive conditions

 

Legal Due Diligence (LDD):

Though our in house counsels and external counsels we are well equipped to carry out the legal due diligence. For an investor a legal due diligence is crucial for decision making. It helps in determining liabilities, negotiating a lower price and managing risk of in a complex country like India. The exercise covers various aspects like Corporate Laws, Loans and Borrowings, Real Estate, Intellectual Property, Contracts, Employment, Licenses, Litigation, Competition Law, etc

Typically, a legal due diligence is a study of the Target, focusing on the following:

  • Regulatory issues
  • Corporate compliances
  • Verifying Loan documents to check for any restrictions on M&A
  • Title over Real Estate and other tangible property
  • Title over Intellectual Property and the risks associated with it
  • Compliance with Employment Laws
  • Existing or potential litigation against the target
  • Licenses and regulatory approvals required for the Business
  • Compliance with environment and other industrial laws
  • Material Contracts

Investigative Due Diligence

Thought our close tie ups with Corporate Investigators we offer Investigative Due Diligence ion the target company. Information is typically gathered in a discreet way through partners, social media, journalists, investors, friends and family, litigation records, corporate records, etc.

This involves the following

  • Reputational due diligence on the target company, promoters, etc in a discreet way
  • Due diligence which is aimed at anti-bribery, corruption, ethics and integrity.
  • Anti-bribery, corruption, ethics and integrity of the target companies are the biggest concerns for foreign acquirers.
  • Post-transactional issues are investigated as well

We also conduct due diligence on Start-ups for Venture Capital Funds.

 

How to Conduct Due Diligence for a Merger or Purchase of a Business?

Regardless of whether you are buying a business as an asset purchase, a division purchase, a company stock purchase, or a corporate merger, you (and/or your corporate attorney) must conduct due diligence on the target company or corporate division.  Due diligence involves an in-depth investigation of the business.  It requires review of a lot of documents by your corporate attorney and a review of the financial reports and tax returns by your financial advisor or accountant.  By conducting due diligence on the target business, you and your corporate attorney will have a thorough understanding of the business — being better able to ascertain a fair purchase price of the business, and identify any surprise business liabilities for which you likely will be liable after you become the business owner.  Due diligence also is important because, depending on the outcome of the due diligence, you (perhaps with the help of your corporate attorney) may want to incorporate certain seller obligations in the term sheet of the deal (e.g., clearing any liens on the assets of the business, obtaining required third party consents, etc.).

Here is my due diligence checklist of the most common items to investigate when conducting due diligence in the buying or merging of a small business (of course, these are among other things to review depending on the facts and circumstances of the specific transaction):

Legal Due Diligence

  1. Corporate Documents (or LLC Documents)

If the target business is a corporation, you (or your corporate attorney) should review the certificate of incorporation, good standing certificate, by-laws, minutes of shareholder and director meetings, shareholder agreements, and any outstanding warrants and option agreements.

If the target business is a limited liability company (LLC), you (or your corporate attorney) should review the articles of organization, good standing certificate, operating agreement, minutes of membership meetings, manager agreement, and any outstanding purchase rights agreements and option agreements.

  1. Agreements

Major Contracts:  You (or your business lawyer) should review all major distributor, supplier and customer agreements, all confidentiality and non-compete agreements, all intellectual property agreements (licenses into and out of the company), and all equipment leases.

Real Estate:  You need to review all real estate leases entered into by the target company (whether as a tenant or a landlord), purchase agreements, surveys (if a long term lease or fee owned), title insurance policies (if fee owned); you should ascertain whether any consents are needed for the contemplated business sale (or merger) transaction, how much the rent liabilities are, whether there are sufficient term(s) remaining on the lease(s), among other things.

Insurance Policies:  Have your risk advisor or insurance agent review all insurance policies carried by the target business to determine if the present coverage is adequate for the business as it is conducted (or plans to be conducted).

  1. Licenses and Permits.  Is the target business required to maintain licenses and permits with the local and state authorities (such as a liquor license or other operating permit)?  If so, you (or your corporate attorney) need to obtain all copies and determine which licenses may require the seller’s obtaining prior consent for the contemplated sale or merger of the business.
  2. List of all (major) Assets and Liabilities.  Regardless of whether you are buying the business as an asset purchase or a stock purchase, you want to be sure of what the target company owns and owes.  The target company’s assets may include cash, securities, equipment, inventory, intellectual property (copyrights, trademarks, patents, domain names, and other proprietary rights), notes and accounts receivables, real property (leased and owned).  Liabilities may include bank debt, employee benefits and bonuses earned and not yet paid, threatened, pending and current lawsuits, licensing violations, etc.  You should be provided with a list of all employees and their current salaries.  You should identify which employees are key to a successful transition and continued operation of the business.
  3. UCC Liens.  Uniform Commercial Code (UCC) information is important to any business or financial institution contemplating entering into a lien transaction as the secured party (the party providing funds or financing collateral). Knowing the current financial status of the target debtor business before extending credit is crucial, and it is the number of active, existing liens already in effect for that particular debtor party that most interests any future lender or secured party.
  4. Customer Problems.  You can easily search the internet to see if there is any negative publicity or customer complaints about the target business.  The internet is a very powerful tool for viral marketing and unfortunately, for flaming a business.  You don’t want to buy a business that is saddled with a lot of negative consumer awareness.

Financial Due Diligence

You should have your accountant or financial advisor review the following diligence materials.  She or he should check whether there are any questionable accounting practices.

  1. Tax Returns.  Up to 5 years’ prior federal, state and local tax returns, including any sale and use tax returns.  In New York and in other states, the successor to a business may be liable for tax liabilities incurred in the years prior to its purchase of the business.  In order to be certain that you have the same returns that were filed with the taxing authorities, you can have the seller provide the applicable written consent so you can request copies of the actual tax returns directly from the applicable taxing authority.
  2. Financial Statements.  The seller of the business should provide detailed financial statements (including balance sheets and profit and loss statements) for the prior 3 to 5 years.  If the target business is large enough, your financial advisor or accountant might request to review “audited” financial statements that have been prepared and certified by a certified public accountant.
  3. Tax Liens.  Your accountant or financial advisor should review the any tax liens filed on any assets owned by the target business.

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