DUE DILIGENCE, REVIEWS AND INVESTIGATIONS
The acquiring of a business carries with it a number of risks in areas that include: financial, legal
& litigation, markets & products, management & workforce, strategic and unrecorded
liabilities. The Firm compiles a work plan to meet client goals, expectations, and concerns, ensuring a
smooth acquisition. The work approach for such goals is a pre-agreed plan with the client.
Due Diligence Review (DDR) is a process, whereby an individual or an organization, seek sufficient
information about a business entity to reach an informed judgment as to its value for a specific
purpose. Dictionary meaning of ‘Due’ is ‘Sufficient’ &
‘Diligence’ is ‘Persistent effort or work’.
Offers to purchase a business are usually dependent on the results of due diligence analysis. This
includes reviewing all financial and legal records including anything else deemed material to the sale.
Sellers could also perform a due diligence analysis on the buyer which would help the seller to be aware
of the buyer’s ability to purchase and of factors that could affect the purchased entity or the
seller after the sale has been completed.
Due diligence is a way of preventing unnecessary harm to either party involved in a transaction.
Mergers & Acquisitions has been the driving force behind DDR. Due to globalization coupled with a
variety of other factors, India has entered into an era of mergers and acquisitions. Some of the reasons
for which a DDR may be carried out are as follows:
- Potential Acquisition
- Merger
- Granting loan for projects
- Venture Capital investment
DDR is not, by itself, an audit. It is much broader than audit and is business oriented rather than
accounting oriented. It should be borne in mind that a DDR requires skills that go beyond conventional
audit. An understanding of the business, the pattern, and trends in the business line, and estimation of
risk - all these are called for from the firm conducting the Review.
SCOPE & OBJECTIVES OF DUE DILIGENCE
It is very much necessary that the scope of DDR is determined in consultation with the client. It is not
confined to financial due diligence but extends to operational due diligence, market due diligence,
technical due diligence, legal due diligence, systems due diligence, etc. all of which form an integral
part of the overall due diligence exercise.
Generally, a comprehensive DDR is undertaken with the following objectives:
- To assess the commercial and technical feasibility, resource availability of the business and
synergy between the organization (acquirer & target).
- To ensure the compliance of necessary statutes and ascertain the liability in the event of
non-compliance.
- To finalize the value of the acquisition or a financial investment.
- Look at tax position/structure and its implications
- Look for overvalued assets or under-recorded liabilities, hidden assets or liabilities.
- Assess the quality of management and identifying key employees of the Target Company.
- To prepare a post-acquisition plan.
- Look into any other significant matters of interest to the acquirer.
- Provide value added information about the target’s business.
TYPES OF DUE DILIGENCE
There are several types of DDR, which are as listed below:
- Business/Market Due Diligence
- Technical Due Diligence
- Human Resource Due Diligence
- Legal Due Diligence
- Environment Due Diligence
- System Due Diligence
- Tax Due Diligence
- Financial & Accounting Due Diligence
APPROACHES
The approach for DDR will depend upon the nature of the target, scope defined by the client, the
structure of the acquisition and the level of the comfort desired. The important principles in designing
a proper approach are:
- Program shall be developed specifying business purpose of the acquisition, critical goals and
objectives, important business units and procedures.
- The team may consist of individuals with the right combination of experience and professionalism
suitable to the task.
- The timetable for completing each step should be framed, documents shall be produced and prepare a
framework for following up on open issues.
- Specific criteria shall be established as to what and how information will be collected and
retained.
- Pragmatic approach should be followed to document conversations, documents received and analysis
performed.
RISK MANAGEMENT
The auditors carrying out DDR is exposed to an inherent risk and has to face financial indemnification of
the consequential loss, if any. To mitigate the risk involved, the following should be ensured:
- Proper understanding of the objective of the assignment before accepting the assignment and deciding
the scope.
- Review of other DDR reports, collect the copy of the same from the client and hold meetings with the
other reviewers.
- Disclose the scope and limitations of the assignment in the DDR Report.
METHODOLOGIES
Methodology of DDR will depend upon the needs of the client, nature of review and time available. Hence,
in any DDR, one will have to follow the steps listed below:
- Understand the needs of the client and decide the scope and objective accordingly;
- Preparation of list of information to be obtained from the client, which is necessary for carrying
out DDR;
- Periodically hold review meetings with the team to ascertain the status of the DDR and further
actions to be taken.
UNDERTAKING FROM THE TARGET COMPANY
As stated earlier, the auditors should take undertakings from the management of the Target Company to
avoid risk. The undertaking should normally cover the following:
- Titles & ownership.
- Various Governments’ consents/licenses.
- Correctness and completeness of all information supplied.
- Product/service warranties, damages, and other claims.
- Contingent liabilities.
- Recoverability of all current assets.
- Registration of Intellectual properties.
- Employee benefit plans.
- Litigation/appeals, etc.
- Non-contravention of regulation, loan covenants, contracts terms, etc.