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Due diligence
1.
© Oxford University
Press 2011. All rights reserved. Chapter 4 Due Diligence
2.
© Oxford University
Press 2011. All rights reserved. What is Due Diligence? Implies an activity involving either the performance of an investigation of a business or person, or the performance of an act with a certain standard of care Also used to mean a required legal obligation although the term more commonly applies to a voluntary investigation Examples: Steps carried out by venture capitalists before and during each investment phase of a start-up company Precautionary steps taken by one company in deciding whether to acquire another i.e. evaluating whether the buy is good or bad.
3.
© Oxford University
Press 2011. All rights reserved. What is Due Diligence? Banking Industry - To act in a prudent manner in evaluating credit applications. Securities Market - Responsibility of underwriters to explain the details of new securities to interested purchasers. Legal Definition - “A measure of prudence, activity, or assiduity, as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent person under the particular circumstances; not measured by any absolute standard but depends on the relative facts of the special case."
4.
© Oxford University
Press 2011. All rights reserved. Activities of Due Diligence Financial Statements: Review and confirm the existence of assets, liabilities, and equity in the balance sheet to determine the financial health of the company based on the income statement. Management and Operations review: Determine quality and reliability of financial statements to gain a sense of contingencies beyond the financial statements. Legal Compliance Review: Check the potential future legal problems stemming from the target's past. Document and Transaction review: Ensure paperwork of the deal is in order and that the structure of the transaction is appropriate.
5.
© Oxford University
Press 2011. All rights reserved. Need for Due Diligence Strengths and weaknesses of the business Gives a fair value of the investment Helps in identifying the apparent irregularities Tool of ensuring that the prevailing system of checks works
6.
© Oxford University
Press 2011. All rights reserved. What does Due diligence involve? Historical Financial Data Current Financial Data Forecasted Financial Information Business Plans Minutes’ of Directors’ Meetings and Management Meetings Audit Paper Work Files Contracts with Suppliers, Customers and Staff Confirmation/ Representations from Financiers, Debtors, etc.
7.
© Oxford University
Press 2011. All rights reserved. Transactions requiring Due Diligence Mergers and Acquisitions: Personnel Financial Operations Marketing Property and Equipments Business Operations Strategic Alliances and partnerships Joint Ventures and Collaborations
8.
© Oxford University
Press 2011. All rights reserved. People Involved in Due Diligence Financial Legal Operational
9.
© Oxford University
Press 2011. All rights reserved. Parties interested in Due Diligence Employees Trade Unions Shareholders Creditors Vendors Customers Government Society
10.
© Oxford University
Press 2011. All rights reserved. Steps in Due Diligence Process
11.
© Oxford University
Press 2011. All rights reserved. Due Diligence Reporting Should reflect a fair and independent analysis & evaluation of financial and commercial information Should ensure collection, analysis and interpretation of financial, commercial and tax information in detail Should provide properly reviewed and analyzed financial information to bidders and various stakeholders Should also provide a feedback on auditing of the special purpose accounts.
12.
© Oxford University
Press 2011. All rights reserved. Types of Due Diligence Financial Due Diligence: involves evaluating a company’s historical, current, and prospective operating results as disclosed in its historical, current and projected financial statements, tax returns, and other information Involves analysis of balance sheet, review from cash to marketable securities, receivables, inventory, prepaid expenses and other current assets, as well as the value of fixed assets.
13.
© Oxford University
Press 2011. All rights reserved. Analysis on the liability side includes accounts payable, taxes, and debt obligations must be closely examined Helps in getting a sense of future revenues Evaluates the underlying assumptions used
14.
© Oxford University
Press 2011. All rights reserved. Legal Due Diligence: Scrutiny of all, or specific parts, of the legal affairs of the target company with a view of uncovering any legal risks and provide the buyer with an extensive insight into the company’s legal matters Improves the buyer’s bargaining position and ensures that necessary precautions in relation to the transaction are taken
15.
© Oxford University
Press 2011. All rights reserved. Objectives of Legal Due Diligence Gathering of information from the target company, Uncovering of the target company’s strong and weak sides, relevant risks and advantages in connection with the transaction, Minimizing the risk of unexpected situations, Improvement of the seller’s bargaining position, Identification of areas where representations and warranties from the seller should be obtained in the acquisition agreement.
16.
© Oxford University
Press 2011. All rights reserved. Documents verified IT law and IT contracts Intellectual property rights Patents, copyrights, and other intellectual property- related documents Company law Financing Employment law Data protection law Consumer protection law General contract law Minutes and consents of the board of directors and shareholders Confidentiality and invention assignment agreements with employees Tax and financial documents Legal disputes and other kinds of conflicts Marketing practices regulation National and EU-competition law Public procurement law.
17.
© Oxford University
Press 2011. All rights reserved. Operational Due Diligence: Involves the on-site analyses of the target business daily processes and of how the business operates. Analysis includes an evaluation of the key employees, managers, independent contractors, suppliers and other factors necessary for the business to conduct normal operations May also cover investigation outside of the actual business.
18.
© Oxford University
Press 2011. All rights reserved. Includes examining work centres, material flow, scrap generation, and inventory levels to identify improvements required to improve productivity and profitability Helps identify and implement changes necessary to increase EBITDA and increasing the multiples due to lower risk. Involves gathering information on: New product or service creation Markets Competition Sales Targets People/Organizational matters
19.
© Oxford University
Press 2011. All rights reserved. Intellectual Property Due Diligence Through analysis needed in this area as economies are increasingly becoming technology driven process of identifying all intellectual property assets, verifying ownership and ensuring that such assets are free of encumbrances for the intended business use is fundamental to any merger, acquisition or investment
20.
© Oxford University
Press 2011. All rights reserved. Examples range from the ingredients and manufacturing process for coke, a closely guarded trade secret, to the many domestic and international trademarks owned by multinational conglomerates such as Tata, HUL, Reliance, etc.
21.
© Oxford University
Press 2011. All rights reserved. IT Due Diligence; Involves scrutiny of IT systems and processes in use and ascertaining better ways of deriving value and leverage from IT assets Involves: Sending an IT request list to the acquired company Compiling an onsite discovery process outline Conducting a review of the requested materials Scheduling and coordinating the onsite visit
22.
© Oxford University
Press 2011. All rights reserved. Human Resource Due Diligence: Involves valuing the contribution of HR Helps by: Establishing a link between organizational objectives and the HR function Determining HR's influence on the skills and motivation of the workforce Determining the managers views of the HR function Ascertaining the outcomes produced by the HR deliverables Measuring the adequacy of HR measures, metrics and benchmarks Ascertaining the total cost of the HR function and industry comparisons Ascertaining the HR team structure, skills and motivation.
23.
© Oxford University
Press 2011. All rights reserved. Areas covered Organizational culture Executive compensation and “golden parachute” contracts Collective bargaining agreements and potential change of ownership liabilities Defined benefit and contribution pension plans Postretirement benefits Retention and severance plans Health and welfare insurance structure and reserves HR functional structure and service delivery HR Information System (HRIS) and Employment Litigation
24.
© Oxford University
Press 2011. All rights reserved. Litigation Analysis When one company sells or otherwise transfers all its assets to another company, the successor is not liable for the debts and tort liabilities of the predecessor. Successor may be liable, however, under the following circumstances: If it has expressly or implicitly agreed to assume liability If the transaction is a merger or consolidation If the successor is a “mere continuation” of the predecessor If the transaction was fraudulently designed to escape liability.
25.
© Oxford University
Press 2011. All rights reserved. Components of Litigation Analysis Customers -- as well as competitors, suppliers, and other contractors—might sue over: contract disputes cost/quality/safety of product or service debt collection, including foreclosure deceptive trade practices dishonesty/fraud extension/refusal of credit lender liability other customer/client issues restraint of trade
26.
© Oxford University
Press 2011. All rights reserved. Employees -- including current, past, or prospective employees or unions—might sue over: breach of employment contract defamation discrimination employment conditions harassment/humiliation pension, welfare, or other employee benefits wrongful termination
27.
© Oxford University
Press 2011. All rights reserved. Regulators might sue over: antitrust (in suits brought by government) environmental law health and safety law
28.
© Oxford University
Press 2011. All rights reserved. Shareholders might sue over: Contract disputes (with shareholders) Financial transactions (such as derivatives) Investment or loan decisions Divestitures or spin-offs Fraudulent conveyance M&A scenarios (target, bidder) Dividend declaration or Change duties to minority shareholders General breach of fiduciary duty Proxy contents Executive compensation (such as golden parachutes) Inadequate disclosure Recapitalization Financial performance/ bankruptcy Insider trading Share repurchase Stock offerings
29.
© Oxford University
Press 2011. All rights reserved. Suppliers might sue over: antitrust (in suits brought by suppliers) business interference contract disputes copyright/patent infringement deceptive trade practices
30.
© Oxford University
Press 2011. All rights reserved. Does Due Diligence insure against M & A failure? Helps avoid: Able to avoid unnecessary losses and expenses The organization’s governing body is able to demonstrate that it has engaged in effective oversight and Senior officers of the company avoid job- and bonus- threatening adverse events
31.
© Oxford University
Press 2011. All rights reserved. Due Diligence involving Financial Issues Can lead to significant unbudgeted liabilities and the diversion of time and energy of key executives Helps identify fictitious bills and fictitious originals created such as the signature-authority list. Helps identify dormant bank accounts for they are a breeding ground for manipulative practices. Unexpected voiding of invoices from the organization’s accounts receivable system should be investigated, particularly if your organization is structured so that people who have the ability to void an invoice also have the ability to receive or issue cheques
32.
© Oxford University
Press 2011. All rights reserved. Due Diligence Involving Organizational Records Periodic review of the minutes of board meetings needs to be done. Record retention policies are often advocated across countries as a reliable tool of reference.
33.
© Oxford University
Press 2011. All rights reserved. Due Diligence involving Legal Compliance Helps ensure that the organization is in compliance with applicable law Depending on the nature and size of an organization’, professional advisors should be engaged to evaluate the laws and regulations as applicable, and to help management design a due diligence plan Compliance can be achieved in an orderly, cost- effective and timely manner
34.
© Oxford University
Press 2011. All rights reserved. Due Diligence involving Interaction of Contracts Involves due diligence of key contracts and agreements, and summarizing and cross- referencing Critical for future reference Help in avoiding inadvertent conflicts.
35.
© Oxford University
Press 2011. All rights reserved. Due Diligence involving Information Systems Helps to get tuned to the rapid shift from manual system infrastructure to technology driven infrastructure. Ensures adherence to regulatory compliance that are coming into force.
36.
© Oxford University
Press 2011. All rights reserved. Due Diligence involving Key Customers and Suppliers Strong need to initiate ongoing monitoring of the operations and plans of key customers and suppliers as can reveal important information on its current financial and operational status and near- term future events. Also reveal a deteriorating financial condition in advance.
37.
© Oxford University
Press 2011. All rights reserved. Effective Due Diligence team Have members with first hand experience in the industry to which the target belongs Have members with expertise in different areas such as HR specialists, Functional area managers, individuals with knowledge of national culture, etc. Capable of quickly identifying both the positive and negative aspects of the property to be acquired. Willing to carry out a site visit to evaluate the current condition of the assets to be acquired; both the physical assets as well as the personnel Have members who possess excellent negotiation skills Have people who have time to lead the project and serve as team members
38.
© Oxford University
Press 2011. All rights reserved. Ensure that the diligence team is co-located within a secure environment, such as a corporate headquarters or closer to the target Be familiar with the strategic and financial rationale behind the acquisition Train the team to identify and home in on specific issues Develop and communicate rules of engagement between the diligence team and the target company Make available analytical tools and techniques so the team can rapidly get its arms around potential synergies and integration challenges Healthy flow of information
39.
© Oxford University
Press 2011. All rights reserved. Why Due Diligence fails? Failure to Focus on Key Issues Failure to Identify New Opportunities and Risks Failure to Allocate Adequate/ Right Resources
40.
© Oxford University
Press 2011. All rights reserved. Thank you!
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