JOINT VENTURES AND ACQUISITIONS

DUE DILIGENCE

SUBMITTED BY: VRINDA GUPTA M/BFT/10/32 SEMESTER-VI

WHAT IS DUE DILLIGENCE Due Diligence is the process of evaluating a prospective business decision by getting information about the financial, legal, and other material (important) state of the other party. Due diligence is used most often when buying a business, as the buyer spends time going through the financial situation of the business, legal obligations, customer records, and other documents. The prospective buyer wants to validate his/her opinion of the business to see if it is truly a good decision. If you don't do your "due diligence" in a business situation, you may end up buying something that isn't as you thought it was, or you may end up in a business relationship that will cause you trouble. It may be costly to perform due diligence, because it usually involves the services of a CPA and an attorney. Due diligence is a process which includes detailed review of all aspects of a business or a situation, including financial, legal, insurance, technology, and marketing/sales/competition, as well as general company information. Due diligence is used to investigate and evaluate a business opportunity. The term due diligence describes a general duty to exercise care in any transaction. As such, it spans investigation into all relevant aspects of the past, present, and predictable future of the business of a target company. Due diligence serves to confirm all material facts in regards to a sale. Generally, due diligence refers to the care a reasonable person should take before entering into an agreement or a transaction with another party. The term originated in the business world, where due diligence is required to validate financial statements. The goal of the process is to ensure that all stakeholders associated with a financial endeavour have the information they need to assess risk accurately. When due diligence involves the offering of securities for purchase, as in an IPO (initial public offering), specific corporate officers are responsible for the proper completion of the process, including the issuer, issuer's counsel, underwriters, CFO and the brokerage firm offering shares. Because of the delicate nature and importance of such judgments to the prospects for the performance of a company's equities in the public market, there is a strong emphasis on neutral, unbiased analysis of both the current financial state and future prospects of the firm in question. In compliance, due diligence describes the degree of effort required by law or industry standard. In real estate, due diligence is the time period between the acceptance of an offer and the close of escrow. In civil law, due diligence is synonymous with "reasonable care."

When a patent is issued, due diligence is the requirement that the patent holder should develop a product around the patent, and not just prevent others from doing so. PROCESS: The process involves both the principal (buyer or investor) and an accountant and attorney. In a business purchase, it is usually performed after the intent to purchase documents has been signed but before the formal purchase agreement. During due diligence, you should:

Examine all records and documents. Spend time at the business location, talking to managers, executives, employees. Check sales against customer lists to verify that the business has the customers it says it does Look at potential future plans for expansion, condition of facilities, equipment, furniture and fixtures to verify that they are as reported Look at all documents which might incur liability for the company, including sales agreements, purchase agreements, liens on assets With the assistance of your attorney, examine documents relating to any on-going or potential lawsuits, and recent litigation that has concluded.

Most important in the due diligence process is to take note of discrepancies between what is reported and what is actually going on. Ask lots of questions; if you don't get satisfactory answers, ask why. It's sometimes necessary to prove the negative as well as the positive. Remember, if it doesn't seem right, it probably isn't. What subjects are included in the due diligence process:

Although the subjects involved in the due diligence may change based on the situation, most of the time the due diligence process includes the following:

General company information A history of the company, its original and any succeeding business plans, the company's mission statement and shot-term and long-term goals and objectives would be necessary here.

Company management and employees

Legal matters An investigation of the legal structure of the business might include viewing copies of the articles of incorporation, by laws, minutes of meetings, and formation documents filed with the state. Other legal documents would be copies of contracts and agreements binding the company, and warranties/service agreements on company products and any product liability documents. A discussion of current or pending

litigation should be included, as well as any relationships with regulatory agencies like OSHA, ADA, or industry-specific organizations. A listing of all employees, along with an organization chart, is necessary, including the resumes of executives and board members, and copies of employment contracts. Information about company advisors - legal, financial, insurance, and other - should be disclosed. Background checks should be performed on all top executives and board members. The employee handbook and other documents relating to employee pay and benefits need to be reviewed. Review Employment tax reports (Form 941, Form 940 and others), both federal and state. Check the status of independent contractors to make sure they are correctly classified.

Products and services If the company sells products, a catalogue or listing of products is needed, along with information about competitiveness of these products. Brochures and price listings for products and services also must be reviewed. Pricing strategies, service availability and terns if sake are needed, Documents relating to company patents, copyrights, and trademarks must be provided, as well as licenses owned by the company and agreements with licensees.

Marketing and Competition information Documents needed include the company's marketing plan, market analysis, growth opportunities, a SWOT analysis, and purchase agreements. Information about the competition might include lists of major competitors, and analysis of the competition - present and future.

Customers. Information about customers includes review of agreements with major customers and accounts receivable aging reports.

Operations The due diligence process includes review of fixed assets, facilities, and equipment, product quality assurance and safety, suppliers and contracts. Inventory is often taken and inventory costing (LIFO and FIFO) is considered.

Financial matters Most important to the due diligence process are financial records. Records reviewed include balance sheets and income statements for past years, projected financial statements, insurance coverage, tax filings, and sources and uses of funds statements. Verify profitability and check company financial data against common financial ratios. Check owner income against business profits; if the business is a corporation, verify shareholder dividends and K-1 forms.

THE IMPORTANCE OF DUE DILIGENCE Effective due diligence deploys a structured methodology and trained personnel to review key components of a financial transaction, and communicate in a timely manner related results for decision-making with regard to structuring and/or monitoring the proposed or existing extension of credit. This can be through a warehouse line of credit, term loan, and securitization, servicing platform or other means. Information obtained via objective and independent due diligence is a critical component of the lending process, and such efforts directly affect the confidence that key parties including lenders, issuers and investors have in the credit markets. Issue There is growing concern, publicly and privately, about the depth, quality and timeliness of due diligence performed by financial institutions. Several questions need critical attention, such as: What should the scope of procedures include? How large should the sample sizes be? Who should execute the procedures? How often should the procedures be performed? What should the reporting of results consist of? How can we work efficiently with the borrower? Relying on a weak methodology, unqualified or inexperienced resources, or a poorly defined project plan to conduct due diligence magnifies the risk associated with these questions. This also results in a cumbersome, untimely and ineffective process that does not produce the key information needed for effective decision-making. Challenges and Opportunities There are numerous challenges in the due diligence process, including: The scope of procedures may not be well-defined, leaving key credit committee questions unanswered. Information requested may be poorly communicated; the borrower may have to spend extra time gathering new or different data than expected. Transaction responsibilities and timelines may not be well-understood; critical matters uncovered during due diligence may not be communicated to the appropriate people. At the same time, there are many benefits to employing effective due diligence: Fewer unanswered questions by credit committees; higher confidence in credit granting

 Improved relationships and more open communication among the due diligence participants Reduced effort on behalf of all parties in the due diligence process, allowing for lower overall costs or increased coverage Reduced regulatory findings, as a strong, repeatable due diligence process demonstrates commitment to sound credit risk governance Effective due diligence carries the added benefit of improving confidence levels in the capital markets. Analysis Effective due diligence helps interested parties: Objectively understand the assets and their underlying historical performance, including deviations from historical and recent trends. Identify key risks faced by the lender and establish a communication framework to address these risks, including potential risk mitigation efforts. This could also result in dealstructuring alternatives such as pricing considerations, collateral requirements or enhancements to required periodic reporting. Develop an understanding of critical policies and procedures used to prepare information used for decision-making and identify potential areas of information weakness. Provide a framework to address questions and concerns, allowing each party to focus on making sound business decisions. Although not specifically designed to identify fraud, effective due diligence may also reveal key indicators of potential fraudulent activity, such as: Unusual transactions Discrepancies in accounting records Missing/conflicting evidential matter Activities/transactions outside the normal course of business Changes in important credit and underwriting policies and procedures Market confidence relies on and will improve with more effective and frequent due diligence. Todays environment requires world-class due diligence service providers that can provide powerful insights on potential weaknesses or other transaction variances that ultimately could lead to a nonperforming asset.

STAFF FUNCTIONS LEGAL STAFF Lawyers are the single most critical element in Due Diligence team as an acquisition is the purchase of pool of legal rights and obligations in addition to brands and assets. They ensure that buyer is getting what he thinks he is getting when he buys a company. There are two types of lawyers, in-house and outside. For most of the deals especially the larger ones some combination of inside and outside lawyers is ideal.

IN-HOUSE LAWYERS In-house lawyers provide general counsel. In-house lawyers are more knowledgeable about the business and the priorities, preferences etc. In-house lawyers are a small team. In-house lawyers lead the legal team as they have responsibility to the top management and they can spot business specific issues.

OUTSIDE LAWYERS Outside lawyers are employees of law firms that can be hired on a deal or a project Outside lawyers are more experienced in doing deals. Outside lawyers generally have large resources. By contrast outside counsel are valuable as experts in more complex M&A issues, tax laws, environmental laws etc. Outside lawyers can get help on uncovered issues quickly as they can draw on the vast resources at their disposal. Outside lawyers can bring on the table other resources for drafting of ancillary and main documents

FINANCE AND ACCOUNTING STAFF Finance team measures the worth of the deal. The work of developing valuation and financial models is usually split between finance staff and the corporate development team. Like legal team financial resources can be found both inside and outside - Inside finance staff will have the advantage of understanding buyers accounting policies while outside team will know to study the targets accounting and practices vis--vis buyers - Generally the finance team of is led by the insider as they are responsible for the financial statements of the buyer and the combined entity - In most cases the outside team is from the buyers audit firm as buyer already has an on-going relationship with them. Secondly, this is the audit firm which ultimately comments on the combined entity.

HUMAN RESOURCES STAFF HR staffs are brought in to plan for integration of human capital of combined entity. Their role in due diligence: - Outside team is brought in a situation when the buyer is acquiring a target in unfamiliar environment and where the cultural difference, compensation etc. are vastly different. - The role is more important when retention of human capital of target team is critical for success of the combined entity. REAL ESTATE STAFF Real estate team is brought in generally for operating evaluation of real estate capital. This changes considerably when the acquisition is in the real estate sector. REGULATORY AND COMPLIANCE STAFF Involvement of regulatory and compliance team vary from deal to deal. It depends on the environment in which the target company is operating. - Regulatory lawyers usually have a deep knowledge of regulatory structure. - Compliance lawyers have deep understanding of how to comply with the regulations as they regularly deal in these matters and hence develop expertise in it. PUBLIC RELATIONS STAFF Public relation staffs are usually brought in the last stage: - To manage the press coverage and public relations of the transaction. - Companies often use outside PR firms to do this job. Many times the PR firms have to assess reactions of government departments, political parties, social pressure groups etc.

LINE FUNCTIONS Line functions provide crucial specialty expertise in a variety of areas: - They are required to develop a detailed and accurate understanding of the business being acquired. - Chosen and utilised to focus on specific issues or problems. - To analyse the political and human resource issues. Corporate staff can maintain certain amount of distance from the result of the acquisition. As against this the strategic transaction can have significant impact on the careers of the line staff: - The most obvious impact is redundancy. In many cases an acquisition brings on staffs that are duplicative with buyers existing team. - It is more common to lay off buyers staff. - Sometimes the line staffs do not lose their job as a result of acquisition, but it can be impacted going forward. - An acquisition can signal a shift of resources away from what they are currently doing, thereby reducing their importance. LINE STAFF FUNCTIONS VS. CORPORATE STAFF FUNCTIONS Line staffs have to deal with the challenges of integration, while corporate staffs are insulated from it. - All the duties of assimilating new technology are on the line staff, while the corporate staffs are credited with the task of having acquired it. The management can help moderate these issues. It can alleviate concerns which are not realistic. In many cases line staffs are not privy to the detailed plan of top management. Hence it often makes sense to share these plans. Even when it is not possible to alleviate the fears, understanding what they are and moderating them may be possible. It is important to identify what resources/expertise is required then to leverage them effectively and identify critical issues. The buyer then needs to work with line staff to get those resources this itself is challenge as for the line staff deals are usually a distraction as they are rarely compensated for. MANAGEMENT INVOLVEMENT Involving line management early is often key to an effective due diligence. As the compensation of line staff is driven by the line management it is difficult to get enough support from line staff unless line management is supportive to the deal. - When line management is supportive they will usually be very helpful in providing resources and motivating their staff. - When line management does not support the deal, they may openly oppose it, but they are not enthusiastic about it. This indifference gets percolated down the line. This makes it difficult to marshal the resources effectively If target is operating in the same business, the line manager may have single greatest level of expertise. It is not uncommon to see line managers who do not support the deal, damn it by being overtly against it. Given their position of authority and expertise, this is particularly dangerous. - The key with all staff, particularly with line management, is to try to tie the judgement they make on deal to the eventual result. -

This is usually done best by making those who do due diligence in their area of expertise, are also made responsible for the subsequent integration and performance in that area. It is very important to ensure that whatever predictions and projections line managers make about an acquired business are reflected in their goals and targets.

OTHER LINE STAFF FUNCTION Marketing and sales staff are important for retail and heavily branded business. Product development team can help buyer assess the value of existing products or future products in the pipeline. Operations staff can assess not only the challenges of integration, but also the efficiency of current operations. This will help Buyer identify where increased efficiency can be driven post-merger. Customer service is another area where staff can help the buyer for increased customer satisfaction and compliance. If it is a technology driven acquisition, engineering and development staff can assess the technology, its scalability, security etc. In all above areas the staff can help buyer assess the value of acquisition to arrive at buy vs. build alternative.

THE DIRECTIONS AND DELIVERABLES PROVIDED One of the key factors in effective due diligence from line staff is direction and deliverables: - Setting expectations upfront will ensure that line staff devote efforts in right direction. - All members of due diligence team should have general understanding of the overall business of the target and general idea of how it might be integrated in buyers business. - Each member of the team should be given specific goals and deliverables. - Useful to develop a template for each major area. - It is also important to set up clear timeline. - It is very important to educate line staff on the sensitivities of Strategic Transaction. - Regular communication is very important to dispel all doubts or misconceptions about the deal and its effect.

ROLE OF LEGAL ACCOUNTING FUNCTIONS

Helps Better Understand Your Business. Legal due diligence is necessary to give the buyer the information that it needs to learn about the target company and to structure its purchase of the company. In addition, legal due diligence will help the buyers counsel to become acquainted with the company so that they can communicate effectively with the companys counsel and with the buyer in structuring the transaction. Help to Value the Target Company. The buyer will use the information learned in the legal due diligence process to determine how much to pay for the company. In addition to carefully examining obvious indicators of value such as the companys cash flows and balance sheet, the buyer and its counsel will search for more subtle indicators of value or potential liabilities in things such as (i) the organizational documents and important contracts (e.g., is the company restricted in how or where it operates its business or subject to unusual pricing terms or contingent liabilities), (ii) lawsuits to which the company is a party, (iii) insurance policies benefiting the company, (iv) employee benefit and labour arrangements, (v) potential environmental claims, (vi) intellectual property owned or used by the company and (vii) rights or obligations under earn-outs or indemnification provisions. Help in Drafting the Relevant Documentation. The information learned in the legal due diligence process will be helpful for both the buyers counsel and the companys counsel in drafting and negotiating the merger or acquisition agreement and related ancillary agreements. This information will be particularly helpful in allocating risk when drafting the companys representations and warranties, the companys preclosing promises and the post-closing indemnification rights of the buyer. Further, the company will likely need to prepare a disclosure schedule, to be delivered at the time the primary transaction agreement is executed, that discloses exceptions to the representations and warranties made by the company in the agreement. The information gathered in the legal due diligence process will be helpful for the company and the counsel in preparing the disclosure schedules. In addition, if the transaction includes a securities component, this information will be very helpful in crafting a disclosure document that may need to be delivered to the buyer. Identify Impediments to Closing. In the legal due diligence process the parties will attempt to identify everything that must happen before the transaction can close. For example, counsel will focus closely on (i) the organizational documents, to determine the stockholder and other approvals required to complete the transaction, (ii) the contracts, including assignment clauses, and the permits and licenses, to determine whether the transaction is contractually prohibited or whether specific consents are required; (iii) regulatory requirements, to determine if any governmental approvals are required; and

(iv)

the debt instruments and capital leases, to determine repayment requirements.

*With respect to item (ii), note that if the transaction is structured as a sale of the companys assets, it is likely that you will need to seek consent from the other parties to many of the contracts before assigning the contracts to the buyer. If the transaction is structured as a sale of your companys stock, consent will only be required if assignment is defined broadly to include a change of control transaction (common in real estate leases). If the transaction is structured as a merger, depending on the applicable state statute, whether consent is required may depend on whether it is a forward merger (in which case the legal existence of the company ceases and seeking consents may be advisable) or a reverse merger (in which case the legal existence of the company continues and it is less likely that seeking consents is required).

Legal Opinions. Often the target companys counsel, the buyers counsel or both will be expected to render a legal opinion at the closing of the merger or acquisition transaction. In order to reach the relevant legal conclusions in the legal opinions, counsel will need to rely on factual information provided by the target company. The legal due diligence process provides counsel with the opportunity to learn this information.

ROLE OF FINANCIAL ACCOUNTING

Financial Analysis Analyse whether the financial statements of a business represent actual performance and assess the reasonableness of future projections.

Operational Analysis Analyse revenue and cost levels, supplier contracts and customer relationships to determine efficiency issues and potential cost reductions.

Cash Flow Review Analyse the projections in light of historical results, competitors, and market share and industry trends.

Tax Structuring Analyse tax structure to minimize tax burden.

Background Investigations into Key Employees When conducted properly, a background investigation is a relatively small cost item that can save a client from dire consequences and uncover facts not apparent on the face of the financials or discoverable through traditional audit methodologies.

Acquisition Disputes Analyse the issues relating to Generally Accepted Accounting Principles (GAAP) or changes to the consistent application accounting practices and policies. Determine the effect on the closing balance sheet and historical profit and loss statements. Determine how these GAAP issues may affect the purchase price and closing balance sheet.

Analyses provided may often lead to purchase price adjustments both before and after the closing of the transaction. Sometimes the biggest adjustments come after the transaction closes and a more complete review is performed by the buyer and their internal and external accountants. SOME OTHER FUNCTIONS Identify key business drivers, trends in profitability and significant concentrations of risk Evaluate management's forecast Conduct comprehensive discussions with management and their advisors Perform both buy-side and sell-side due diligence