DUE DILIGENCE IN ACQUISITION

BACKGROUND
BUSINESSES ARE POSITIONING THEMSELVES STRATEGICALLY TO MEET THE CURRENT CHALLENGES OF GLOBAL ECONOMY BUSINESSES ENTERING INTO GLOBAL/LOCAL ALLIANCES TO MAXIMIZE NETWORK EFFECTIVENESS INDUSTRIES GOING THROUGH PHASES OF CONSOLIDATION AND REORGANIZATION BUSINESS DIVERSIFYING FOR SPREADING RISK LOCALLY AND GLOBALLY

WHAT IS A DUE DILIGENCE?

IT IS ESSENTIALLY AN INVESTIGATION TO MANAGE RISKS BROADLY DEFINED THE TERM DUE DILIGENCE IS UNIVERSALLY APPLIED TO INVESTIGATIONS OF INFORMATION PROVIDED BY A POTENTIAL SELLER TO A POTENTIAL BUYER IT IS AN ANALYSIS AND APPRAISAL OF AN ENTITY WITH RESPECT TO BUSINESS RISKS

WHAT IS DUE DILIGENCE

OBJECTIVE OF DUE DILIGENCE IS TO ASSESS THE BENEFITS AND PROBLEMS OF THE PROPOSED ACQUISITION/MERGER BY INQUIRING INTO ALL RELEVANT ASPECT OF PAST PRESENT AND FUTUREOF THE BUSINESS TO BE ACQUIRED/MERGED WITH IT IS NOT A PURE FINANCIAL AUDIT THOUGH SOME ELEMENTS OF FINANCIAL AUDIT LIKE REVIEW OF ASSETS AND LIABILITIES SHOULD BE INCLUDEDC IN THE SCOPE

WHAT IS DUE DILIGENCE

IT IS NOT A PURE FINANCIAL AUDIT THOUGH SOME ELEMENTS OF FINANCIAL AUDIT LIKE REVIEW OF ASSETS AND LIABILITIES WILL OBVIOUSLY BE INCLUDED IN THE SCOPE IT IS USUAL FOR THE DUE DILIGENCE TEAM TO HAVE A LAWYER AND SOME TECHNICAL AND COMMERCIAL PEOPLE FROM THE ACQUIRING COMPANY SO THAT A PROPER TECHNO COMMERCIAL VIABILITY STUDY OF THE TAKEOVER/MERGER TARGET CAN BE DONE

WHAT IS DUE DILIGENCE

DUE DILIGENCE INVOLVES COMPREHENSIVE ANALYSIS OF ALL IMPORTANT TARGET FIRM CHARACTEISTICS INCLUDING MANAGEMENT CAPABILITIES AND ALL ASSETS INCLUDING INTANGIBLE ASSETS CAREFUL ANALYSIS OF COMPANY BEING ACQUIRED REDUCES PROBABILITY OF PAYING UNJUSTIFIED HIGH PRICE FOR ACQUISITION ie NUMBER OF TIMES NETT WORTH DUE DILIGENCE GOES BEYOND FINANCIAL NUMBERS AND CURRENT ASSETS TO INCLUDE CORPORATE CULTURE CRITICAL OUTCOME OF EFFECTIVE DUE DILIGENCE IS THE ASSESSMENT OF THE VIABILITY OF POST ACQUISITION/MERGER INTEGRATION (IBM CONSULTING AND PWC) NEED TO STUDY FINANCIAL RESOURCES WHICH INCLUDE ROA PER EMPLOYEE,EVA,QUANTIFICATION OF LOST BUSINESS OPPORTUNITIES etc

WHAT IS DUE DILIGENCE

EXAMINES CUSTOMER AND MARKET RELATED ISSUES ie CUSTOMER RELATIONSHIPS ,SATISFACTION, MARKET SHARE etc CUSTOMER PROFILE, WALLET SHARE AND LIFETIME VALUE STUDY ANALYSIS OF CORE AND SUPPORT PROCESSES TO JUDGE EFFICIENCY AND EFFCTIVENESS EFFECTIVENESS OF IT SYSTEMS EMPLOYEE EMPOWERMENT EMPLOYEE TRAINING FACILITIES ANALYSIS OF COST OF OPERATIONS

NEED FOR DUE DILIGENCE

UNDERSTAND THE REASONS FOR POOR FINANCIAL PERFORMANCE LOCATE BAD DEBTS TO BE WRITREN OFF AND UNDERSTAND SHORT TERM AND LONG TERM LIABILITIES MORE CLEARLY THAN PROJECTED TRIGGER DISINVESTMENT EXERCISE TRIGGER STRATEGIC INVESTMENTS INCLUDING ACQUISITION FULLY OR PARTIALLY

TYPES OF DUE DILIGENCE

`BUSINESS ASSESS COMMERCIAL FEASIBILITY AND SYNERGY BETWEEN ORGS TECHNOLOGICAL ASSESS PLANT CAPABILITIES HR EXPERTISE OF PEOPLE LEGAL ASSESS IMPACT OF LITIGATION ENVIRONMENTAL IMPACT OF PRODUCTS , SERVICES, PROCESSES ON ENVIRONMENT SYSTEM - IT SYSTEMS ADEQUACY AND SECURITY TAX IMPACT OF UNPAID TAXES FINANCIAL FAIRNESS OF ACCOUNTING POLICIES

SITUATION CALLING FOR DUE DILIGENCE

FIRM CONSIDERING A POTENTIAL ACQUISITION BANKER CONSIDERING GRANT OF LOAN VENTURE CAPITALIST CONSIDERING INVESTMENT BUSINESS BROKER OFFERING COMPANY FOR SALE APPRAISER RETAINED TO ESTIMATE FAIR VALUE OF FIRM

QUESTIONS TO ASK BEFORE M&A

WHAT IS THERE IN TARGET COMPANY THAT WE CANNOT DO OR IS IT A PART ACQUISITION FOR INVESTMENT WHAT IS THE STRATEGY FOR COMBINED ENTITY TO BE BETTER THAN SEPARATE UNITS WHAT LEVEL OF DUE DILIGENCE WILL MINIMIZE RISK OF ACQUISITION

DUE DILIGENCE AS APPLIED TO M&A

DIFFERENCE BETWEEN MERGER AND ACQUISITION IS AS UNDER MERGER OCCURS WHEN ONE COMPANY IS COMBINED WITH ANOTHER IN THE SIMPLEST FORM OF ACQUISITION A FIRM ACQUIRES SHARES OF A COMPANY PARTLY AND MAY NOT INVOLVE ACQUISITION OF LIABILITIES. EG RIL PART INVESTMENT IN OBEROI HOTELS. IF A COMPANY WISHES TO FULLY ACQUIRE A COMPANY IT HAS TO TAKE OVER THE ASSETS AND LIABILITIES OF A COMPANY AND PAYMENT OF GOODWILL WHICH CAN BE SEVERAL TIMES NET WORTH MAYBE INVOLVED THE PROCESS FOR MERGER ON THE OTHER HAND INVOLVES ACCOUNTING NUANCES OWING TO IDENTIFICATION AND VALUATION OF HIDDEN , UNDER VALUED, OR IMPROPERLY ACCOUNTED ENTITIES.PROCESS SHOULD ALSO ASSESS LIABILITIES SUCH AS LEGAL CASES , TAX LIABILITIES , ACCOUNTS PAYABLES AND OTHER LIABILITIES

WHAT TO LOOK FOR IN DUE DILIGENCE PROCESS

OVER VALUED ASSETS ESPECIALLY INTANGIBLES EG SOFTWARE etc OVER VALUED ASSETS OR UNDER RECORDED LIABILITIES QUALITY OF MGT ESPECIALLY EXECTIVE DIRECTORS TAX LIABILITIES AND ITS IMPACTS PENDING SALES TAX OR CUSTOM DUTY ASESSMENTS LOAN LIABILITIES AND DEBT EQUITY RATIO PROJECTED CASH FLOWS CORRECTNESS WITH RESPECT TO PAYMENT FROM INSOLVENT COMPANIES AND PROVISIONS TO WRITE OFF BAD DEBTS LEASE AND OTHER PAYMENT LIABILITIES SUCH WAGE , GRATUITY ARREARS etc ENVIRONMENTAL PROBLEMS UNMOVED INVENTORIES

WHAT TO LOOK FOR IN DUE DILIGENCE PROCESS

UNDERUSED OR OBSOLETE PLANT AND MACHINERY AND THEIR SPARES LITIGATED PROPERTY AND ASSETS ASSETS CARRIED AT HIGHER VALUE THAN CURRENT MARKET VALUE DUE TO FOREIGN EXCHANGE FLUCTUATION

OBJECTIVES OF DUE DILIGENCE

ASSESS COMMERCIAL AND TECHNICAL FEASIBILITY AND RESOURCE AVAILABILITY OF THE BUSINESS ENSURE COMPLIANCE OF NECCESARY STATUTES AND ASCERTAIN LIABILITY IN EVENT OF NON COMPLIANCE ARRIVE AT VALUE OF ACQUISITION

OBJECTIVES OF DUE DILIGENCE

ASSESS BENEFITS AND PROBLEMS OF PROPOSED ACQUISITION TECHNICO COMMERCIAL VIABILITY OF M&A LOOK AT TAX LIABILITIES REVIEW CASH FLOWS LOOK AT OVER OR UNDER VALUED ASSETS OR UNDER RECORDED LIABILITIES

OBJECTIVES OF DUE DILIGENCE

ASSESS QUALITY OF MGT

KEY OBJECTIVES TO ASK BEFORE M&A EXERCISE

WHY SHOULD TARGET COMPANY SELL/AMALGAMATE WHY SHOULD WE TAKEOVER/AMALGAMATE WITH TARGET COMPANY WHAT IS THERE IN THE TARGET THAT WE CANT DO OURSELVES WILL THE COMBINED ENTITY BE BETTER THAN THE SEPARATE UNITS WOULD M&A COMBINE THE WORST OF MEMBER COMPANIES

KEY OBJECTIVES TO ASK BEFORE M&A EXERCISE

WOULD MERGER/ACQUISITION UPSET THE SAME THINGS WHICH ARE THE REASON WHY WE ARE DOING IT IN THE FIRST PLACE MOST METGES FAIL BECAUSE OF LACK OF HOME WORK. PRE ACQUISITION /MERGER PLANNING DUE DILIGENCE IS VERY IMPORTANT AND IF WELL DONE CAN SAVE LOTS OF HEADACHES LATER.M&A PATH IS VIRTUALLY LITTERED WITH LONG LIST OF FAILURES.

WHY AND WHEN DO YOU CONDUCT A DUE DILIGENCE? WHY? Transactions involve substantial financial obligations A characteristic of our business environment is to always present the best picture Essential to determine the undisclosed risks which are attached to the transaction as this may result in the transaction being aborted or affect the purchase price or terms of the agreement

WHEN? Merger and acquisitions Joint ventures Privatisation of state organisations Commercial undertakings for example, stock exchange listings, financing projects and performance based commercial agreements

THE DUE DILIGENCE REPORT This report should contain: An outline of the scope of the review An analysis of the documentation and information revealed

THE DUE DILIGENCE REPORT (cntd) A list of all the information disclosed by investigations (public record searches) Limitations and disclaimers of liability An executive summary which outlines the legal issues identified and advises on the legal implications of proceeding with the transaction (Risks and Liabilities)

FOCUS AREAS OF DUE DILIGENCE

BUSINESS ENVIRONMENT MARKETS,COMPETITION, REGULATIONS SEASONALITY OF SALES DEPENDENCY ON CUSTOMERS , SUPPLIERS ASSESS IMPACT OF CUSTOMER GAIN /LOSS ANALYSIS ON BOTTOM LINE TRENDS IN GROSS MARGINS RATE OF GROWTH SUSTAINABILITY eg RETAILING AND TWO WHEELER BUSINESS IMPACT OF CHANGING COSTS ON MARGINS IMPACT OF FOREX FLUCTUATIONS eg IT COMPANY DEALS IN US APPLICATION AND CONSISTENCY OF GAAP THOROUGH ACCOUNTING OF INVENTORIES ESPECIALLY GOODS AWAITING INSPECTION OR CLEARANCE BY SUPPLIER ,PROJECT INVENTORY,SCRAP,WIP INVENTORY VALUATION METHODOLOGY

FOCUS AREAS OF DUE DILIGENCE

REVENUE RECOGNITION (GOODS IN TRANSIT ,LETTER OF INTENT) EXPENSES NOT INCURRED EXCLUSIVELY FOR BUSINESS eg FOREIGN VACATIONS OTHER THAN PERMISSIBLE LTA STABILITY AND CERTAINTY OF CASH FLOWS FROM OPERATIONS OPERATIONAL CAPEX GROWTH CAPITAL WIP ASSETS ON LEASE eg CODO PETROL PUMPS DEPRECIATION POLICY PLANT CAPACITY VALUATION ESPECIALLY IN PROCESS LAYOUTS ORGANIZATIONAL CONSTRAINTS IN TERMS OF BOTTLENECKS WORKING CAPITAL IMPACT ON FINANCING MANAGEMENT OF BAD DOUBTFUL DEBTS AND ACCOUNTS RECEIVABLES DIFFERENCES IN ACCOUNTING POLICIES BETWEEN ACQUIRER AND TARGET OR DIFFERENT ACCOUNTING PERIODS

FOCUS AREAS OF DUE DILIGENCE

CONTINGENT LIABILITIES SYNERGIES MIS AND ACCOUNTING POLICIES POTENTIAL CHANGES IN SUPPLY CHAIN CONFIGURATION INTEGRATION ISSUES RETENTION OF KEY EMPLOYEES

DUE DILIGENCE CHECKLIST

MEMORANDUM AND ARTICLES OF ASSOCIATION INCLUDING AMENDMENTS BOARD MINUTES FINANCIAL STATEMENTS FOR FIVE YEARS MARKET STUDIES AND REPORTS ON PRODUCTS PATENTS , TRADE MARKS,COPYRIGHTS LICENSES CONTRACTS-SUPPLIER,CONSULTING,EMPLOYEE,FRANCHISEE, LOAN AGREEMENTS,SHAREHOLDER AGREEMENTS,LABOUR AND MANAGEMENT AGREEMENTS PENSION AND PROFIT SHARING PLANS ESOPS WELFARE BENEFIT PLANS INSURANCE POLICIES TENANCY AND LEASE AGREEMENTS

DUE DILIGENCE CHECKLIST

PRODUCT WARRANTY AGREEMENTS ACQUISITION AGREEMENTS TITLE DOCUMENTS TO REAL ESTATE PROPERTY MORTGAGES GUARANTEES

INFORMATION FROM MGT

ANALYSIS OF COMPETITION PAST OPERATING PERFORMANCE PROFITABILITY OF VARIOUS PRODUCTS , SEGMENTS MATERIAL CORRESPONDENCE WITH GOVT AGENCIES PRICING POLICIES,PRODUCT BACKLOGS ,INVENTORIES CUSTOMER SATISFACTION AND BEHAVIOUR DATA

HIDDEN LIABILITIES
PRODUCT WARRANTY CLAIMS AND LITIGATION ENVIRONMENTAL LIABILITIES,CLAIMS PENDING AND THREATENED LITIGATION AGAINST COMPANY GUARANTEES OF 3RD PARTY LIABILITIES LIQUIDATED DAMAGES FOR LATE DELIVERIES PERFORMANCE OR OTHER GUARANTEES GIVEN BY WAY OF BANK GUARANTEES WHICH ARE ENCASHEABLE CONTRACTUAL OBLIGATIONS WHICH CAN LEAD TO LITIGATION eg UNLIMITED WARRANTY

OVER VALUATION OF ASSETS

BAD DEBTS OR RECEIVABLES NOT DUE FOR LONG TIME AND NO INTEREST DUE THEREON SLOW MOVING AND OBSOLETE INVENTORIES PLANT CAPACITY IN EXCESS OF CURRENT REQUIREMENT LITIGATED ASSETS AND PROPERTY(RELIANCE,MAFATLAL) INTANGIBLE ASSETS WHOSE VALUE HAS DIMINISHED eg HUMAN CAPITAL WITH OLD EXPERIENCED PEOPLE RETIRING OR LEAVING

UNRECORDED OR UNDER RECORDED LIABILITIES

SHOW CAUSE NOTICES WHICH HAVE MATURED INTO DEMANDS AS CONTINGENT LIABILITIES IDEMNITY OF LIABILITIES AND CONTINGENT LIABILITIES OF SUBSIDIARY COMPANIES LIABILITY OF PRODUCT CLAIMS , WARRANTY LIABILITIES,PRODUCT RETURNS,DISCOUNTS,LD FOR DELAYS AND LITIGATION

UNRECORDED OR UNDER RECORDED LIABILITIES

ALL TAX LIABILITIES PENDING SALES TAX OR CUSTOM DUTY ASSESSMENTS AGREEMENT TO BUY BACK SHARES AT A STATED PRICE eg HLL LEASELIABILITIES ACTUARIAL AND OTHER LIABILITIES SUCH AS WAGES , PF , SUPERANNUATION WAGE NEGOTIATIONS PENDING

LIMITATIONS OF DUE DILIGENCE

NOT EQUIVALENT TO AQUDIT IN ACCORDANCE WITH GAAP NOT AN EXAMINATION OF INTERNAL CONTROLS SOX 404 AUDIT DEPENDENCY ON INFO AND EXPLANATION GIVEN BY TARGET LACK OF DOMAIN EXPERTISE IN FIELD OF OPERATIONS OF TARGET

CONCLUSION
DUE DILIGENCE PLAYS AN IMPORTANT ROLE IN IDENTIFYING ,QUANTIFYING AND REDUCING RISKS IN ACQUISITION ALTHOUGH DUE DILIGENCE FOCUSES ON NEGATIVE INFORMATION AIM IS NOT TO RAISE OBSTACLES BUT FACILITATE THE TRANSACTION BY IDENTIFYING PROBLEMS /RISKS AND DEVISING SOLUTIONS TO PROBLEMS TO REDUCE/MANAGE RISKS IN ACQUISITION