Last few years have witnessed a phenomenal rise in Mergers and Acquisitions (M&A) transactions all over the globe including India. In India, timely changes in legal and economic dynamics of the business with significant inflow of foreign investment are some of the primary reasons for increase in M&A transactions count.
From a professional perspective, an M&A transaction involves multiple steps:
a) pitching the idea of M&A
b) Bidding Process
c) Execution of Non-disclosure Agreement
d) Due Diligence process
e) Execution of deal documents to conclude the deal.
Due diligence is the crucial step and goes to very heart of any M&A transactions as it enables a prospective buyer or investor to study extensively the existing state of legal, compliance, business, economic and regulatory affairs of the target entity.
Due diligence is the process that involve the review and analysis of the documents and information relating to the target entity to ensure, among other considerations:
a) Target entity is in compliance with legal, regulatory and compliance requirements and there are no non-compliance issues.
b) Financial information is reflecting actual state of company’s legal and business affairs and there is no twisting or intentional hiding of crucial financial and business information
c) Company has a clean record without any kind of involvement in any fraud or misrepresentation.
Typically, Due Diligence will start with the request of the required documents (legal, business and financial) and information and any related questions from the target entity by the Buyer or Investor. Legal, financial and deal teams of the buyer or investor review such documents in detail to decide to proceed with the deal transaction or not to proceed with the deal transaction.
It is always helpful to develop a customized due diligence check list in line with legal, business and economic requirements of the company which play a crucial role in conducting due diligence in a systematic and organized manner – you should not let a single of piece crucial information about target entity to slip away.
There are multiple benefits of having a customized check list in place as listed below:
a) Buyer or investor will have the opportunity to study the target entity current and future business prospects in real time prior to deciding to proceed or not to proceed with the deal transaction
b) Deep research and study of first-hand financial information of the company will enable buyer or investor to decide price to be paid for the target entity
c) Buyer or investor will be able to read and understand the business dynamics of the target entity in its true sense and to identify any undisclosed or hidden crucial information that could influence the decision making of buyer or investor about the transaction.
d) Important findings of due diligence are the key driving factors in negotiating deal pricing and terms and conditions of the transaction documents between the buyer or investor and target entity.
e) Ultimately, due diligence enables the parties to know each other well and pave way for conclusion of the transaction on a right note with a cordial relationship.
Execution of a Non-Disclosure Agreement and MOU / Letter of Intent by the parties involved in the M&A Transaction opens the window for the due diligence process. Target entity provides all the documents and information as requested by the buyer or investor.
Upon receipt of such documents and information, buyer or investor’s deal team starts performing due diligence on the Company and list out questions (if any) to target entity and potential risks, issues and liabilities involved in the deal transaction.
If the deal team decides that more information is needed to further study the target entity then they will ask appropriate questions to the target entity and if needed be, may also ask for meeting or interactive sessions with the employees or personnel of the target entity to get information needed to further understand the legal and business affairs of the target entity.
The outstanding focus of due diligence will be on the following objects:
- Economic status of the target entity
2. Legal (including contractual and litigation), economic and business risks and liabilities involved in the deal transaction
3. Legal and economic benefits that could be availed by the buyer or investor with the purchase of the target entity
4. Any other potential risks and liabilities and side effects of the deal transaction on the buyer or the investor.
The beauty of due diligence process is that it is not only instrumental in decision making of buyer or investor about proceeding with the deal transaction and bring to light any conflict of interests, breach or potential of contracts or laws, acts of fraud or misrepresentation etc.
Proper due diligence serves the buyer and target entity in different ways. From buyer perspective, it will enable the buyer to learn all actual or potential risks and liabilities involved in the deal transaction and will enable buyer to decide the risk of investment in the target entity is worth taking. From target entity prospect, it will enable target entity to see the real economic value of it in market of target entity in the prevailing market conditions.
Illustrative List of documents required for due diligence:
A) Governing documents (i.e Memorandum, articles of incorporation, and bylaws), and other documents relating to the Company’s policies, and procedures.
B) Prospectus and related documents (in case of public entity).
C) List of professional and business contracts executed by the Target entity.
D) Statutory filings (actual filed and about to be filed)
E) Property documents relating to movable and immovable property
F) Loan related documents (i.e lease agreements, loan and mortgage documents etc.,)
G) Documents relating to existing litigation matters or other existing disputes or potential disputes.
Cost of Due Diligence
There is no fixed criteria in evaluating cost associated with due diligence process as scope and duration of due diligence process and involvement of third party agencies will significantly increase or decrease of costs associated with due diligence.
Typically, buyer or seller require support from professional advisors (Bankers, lawyers, accountants, agents and consultants) in evaluation of the target entity in terms of legal, finance and business as long as buyer or seller has well organized inhouse team to cater the required support without the necessity of engaging any outside professional advisors or with limited engagement of outside professional advisors will reduce costs of due diligence to a considerable extent.
Further, scope and duration of due diligence process is another factor that could influence scale of costs of due diligence process.
Ultimately, scope and duration of due diligence process and engagement of external support staff will decide the cost of entire due diligence.
Conclusion:
It is evident that due diligence is critical step in the entire deal transaction process as it will decide the outcome of any transaction. Any negligence in due diligence could cost buyer or seller a fortune due to missing critical information.
To conclude, Buyer or seller should not take risk shots at the stage of due diligence and needs to engage and involve team of experts (legal, economic and business) and provide them with the required support to ensure due diligence process is appropriately conducted keeping the best interests of buyer or target entity in mind.
