OVERVIEW OF DUE DILIGENCE IN CONCEPT WITH

FINANCIAL DUE DILIGENCE.

A BRIEF INTRODUCTION TO DUE DILIGENCE.

Imagine you are buying a house. The owners tell you that they are interested in selling
because they are close to retirement and want to downsize to an apartment in the city.
They also assure you that, other than a few minor cosmetic repairs, the house is in great
condition. Would you, or any other home buyer, simply take the owners’ word that the
house will be a great investment for you?

Of course not! You would do your own research on the property, as well as contact a
professional such as a home inspector, to ensure that there weren’t any nasty surprises
lurking beneath the surface. If you do this for your home purchase, why wouldn’t you do
so for your business? And yet a surprising number of people buying businesses fail to
complete the necessary steps to ensure that the company they are purchasing is as sound
and profitable as the current owners claim.

Due diligence in relation to buying a business is when the potential buyer thoroughly
investigates the business. Its operations, profits, accounting, and workforce—these are
some examples of the areas of the business that can and should be subjected to due
diligence.
One of the benefits of completing your due diligence before purchasing a business is that
you are able to obtain a clearer picture of the health of the business while ensuring that
information that would prevent you from purchasing the business comes to light. A
business seller, for example, could tell you that the business always makes a profit and
the reason for sale is the death of another owner. However, on closer inspection, it could
be possible that the real reason the seller is getting rid of the business is that it has
consistently lost money over the last few years. Knowing the truth ahead of time could
save you from purchasing a “black hole” business—one that will consume your
resources, energy, and money without a future payoff.

Another way that your due diligence can help you make the right purchasing decision is
that it reveals the status of the company’s books. A close inspection of the debits and
credits in the accounting records could reveal modified figures designed to make the
business more attractive to buyers. Worse, you may discover that the business owes a
large amount of debt to suppliers, distributors, or even the IRS. Completing due diligence
on a business’s accounting records and practices can give you a clearer picture of the
profitability of the company and ensure that you aren’t “inheriting” a large amount of
debt with the purchase.

Due diligence gives you the reliable and verified information you need to make a smart
purchasing choice. Before you sink thousands, or even millions, into a business, consult a
qualified attorney who can help you navigate both the due diligence and purchasing
processes.

DEFINITION OF DUE DILIGENCE

1. General:

Measure of prudence, responsibility, and diligence that is expected from, and ordinarily
exercised by, a reasonable and prudent person under the circumstances.

2. Business:

Duty of a firm's directors and officers to act prudently in evaluating associated risks in
all transactions.

3. Investing:

Duty of the investor to gather necessary information on actual or potential risks involved
in an investment.

4. Negotiating:

Duty of each party to confirm each other's expectations and understandings, and to
independently verify the abilities of the other to fulfill the conditions and requirements of
the agreement.

MEANING OF DUE DILIGENCE.

Due diligence is an investigation or audit of a potential investment or product to confirm

all facts, such as reviewing all financial records, plus anything else deemed material. It
refers to the care a reasonable person should take before entering into an agreement or a
financial transaction with another party. Due diligence can also refer to the investigation a
seller does of a buyer; items that may be considered are whether the buyer has adequate
resources to complete the purchase, as well as other elements that would affect the
acquired entity or the seller after the sale has been completed.

In the investment world, due diligence is performed by companies seeking to make

acquisitions, by equity research analysts, by fund managers, broker-dealers, and of course
by investors. For individual investors, doing due diligence on a security is voluntary, but
recommended. Broker-dealers, however, are legally obligated to conduct due diligence on
a security before selling it. This prevents them from being held liable for non-disclosure
of pertinent information.

HISTORY OF DUE DILIGENCE.

Due diligence became common practice (and a common term) in the U.S. with the
passage of the Securities Act of 1933. Securities dealers and brokers became responsible
for fully disclosing material information related to the instruments they were selling.
Failing to disclose this information to potential investors made dealers and brokers liable
for criminal prosecution. However, creators of the Act understood that requiring full
disclosure left the securities dealers and brokers vulnerable to unfair prosecution if they
did not disclose a material fact they did not possess or could not have known at the time
of sale. As a means of protecting them, the Act included a legal defense that stated that as
long as the dealers and brokers exercised "due diligence" when investigating companies
whose equities they were selling, and fully disclosed their results to investors, they would
not be held liable for information not discovered during the investigation.

A standard part of an initial public offering is the due diligence meeting, a process of
careful investigation by an underwriter to ensure that all material information pertinent to
the security issue has been disclosed to prospective investors. Before issuing a final
prospectus, the underwriter, issuer and other individuals involved (such as accountants,
syndicate members, and attorneys),will gather to discuss whether the underwriter and
issuer have exercised due diligence toward state and federal securities laws.

BASICS OF DUE DILIGENCE.

The practice of undertaking a formal due diligence investigation is of comparatively

recent origin in India and was mainlyimported as a process by foreign investors/their
legal and financial advisors after the economic liberalisation reforms of 1991.

Due Diligence is the assessment that a prudent person might be expected to exercise in
the examination and evaluationof risks affecting a business transaction. It should be the
first step taken before embarking on any successful national or international business
venture.

Due diligence is a detailed investigation of the affairs of a business. As such, it spans

investigation into all relevantaspects of the past, present and predictable future of the
business of a target company. Due diligence is a process of athorough and objective
examination that is undertaken before corporate entities enter into major transactions
such as mergers and acquisitions, issuing new stock or other securities, project finance,
securitization, etc.
One of the key objectives of due diligence is to minimize, to the maximum extent
practicable, the possibility of there being unknown liabilities or risks. The exercise is
multi-dimensional and involves investigation into the business, tax, financial, accounting
and legal aspects of an issuer. The aim of due diligence is to identify problems within the
business particularly any issues which may give rise to unexpected liabilities in the
future.

A question may arise why due diligence should be conducted. There are many reasons for
doing so, including the following:

ü Confirming that the business is what it appears to be;

ü Identifying potential "deal killer" defects in the target and avoiding a bad business
transaction;

ü Gaining information that will be useful for valuing assets, defining representations
and warranties, and/or negotiating price concessions; and

ü Verification that the transaction complies with investment or acquisition criteria.

ü Public Issue of Securities

ü Good Corporate Governance

Due diligence involves a number of different areas of investigation. For example, the
company’s financial status will be assessed by accountants and the pension arrangements
will be the subject of an actuarial review. Due diligence is the necessary amount of
diligence required in a professional activity to avoid being negligent. This commonly
arises in major acquisitions where the legal principle of caveat emptor (let the buyer
beware) requires the purchaser to make a diligent survey of the property or service.

The approach to due diligence depends on the type of transaction and what is intended to
be achieved. Due diligence may be of various types:

ü Commercial due diligence – review of industry, market, and the business model of
the issuer.
ü Reputational due diligence – review of credit worthiness and reputation of individual
counterparties.

ü Financial, Accounting & Tax due diligence – review of tax, financial position,
policies and internal controls.

ü Legal due diligence – review of documentation to identify potential legal issues that
may be risks/impediments to the (i) transaction or (ii) in the general operations of the
issuer, that may affect the value or consideration in connection with the transaction.

ü Human resource Due diligence – review of documentation related to management

contracts, bonus schemes,

option schemes, details of all employees, consultants, contractors, etc

ü IT Due Diligence – review of information on software licences, data management

procedures and copies of IT audit conducted.

ü Operations Due Diligence - review of all operations and their role, utilisation &
capacity of each operation.

A little due diligence can go a long way in protecting the business capital and reputation.
There is no substitute for a thorough investigation. In these days of strict adherence to
regulations, territory.

Experience has demonstrated that time and money invested in due-diligence

investigations have saved manycorporations from financial disaster and irrevocable
reputation embarrassment. Due Diligence is no longer a luxury; it isa requirement to meet
legal and regulatory requirements and to promote corporate integrity and customer
confidence

SCOPE AND 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.

1. Generally, a comprehensive DDR is undertaken with the following objectives:

2. To assess the commercial and technical feasibility, resource availability of the

business and synergy between the organisation (acquirer & target).

3. To ensure the compliance of necessary statutes and ascertain the liability in the
event of non-compliance.

4. To finalise the value of the acquisition or a financial investment.

5. Look at tax position/structure and its implications

6. Look for overvalued assets or under recorded liabilities, hidden assets or

liabilities.

7. Assess the quality of management and identifying key employees of the Target
Company.

8. To prepare a post-acquisition plan.

9. Look into any other significant matters of interest to the acquirer.

10. Provide value added information about the target’s business.

BUSINESS TRANSACTION AND CORPORATE FINANCE.

Due diligence takes different forms depending on its purpose:

11. The examination of a potential target for merger, acquisition, privatization, or

similar corporate finance transaction normally by a buyer. (This can include self
due diligence or “reverse due diligence”, i.e. an assessment of a company, usually
by a third party on behalf of the company, prior to taking the company to market.)

12. A reasonable investigation focusing on material future matters.

13. An examination being achieved by asking certain key questions, including, how
 do we buy, how do we structure an acquisition, and how much do we pay?

14. An investigation of current practices of process and policies.

15. An examination aiming to make an acquisition decision via the principles of

valuation and shareholder value analysis.

The due diligence process (framework) can be divided into nine distinct areas:-

16. Compatibility audit.

17. Financial audit.

18. Macro-environment audit.

19. Legal/environmental audit.

20. Marketing audit.

21. Production audit.

22. Management audit.

23. Information systems audit.

24. Reconciliation audit.

It is essential that the concepts of valuations (shareholder value analysis) be linked into a
due diligence process. This is in order to reduce the number of failed mergers and
acquisitions.

In this regard, two new audit areas have been incorporated into the Due Diligence
framework:

the Compatibility Audit which deals with the strategic components of the transaction and
in particular the need to add shareholder value and

the Reconciliation audit, which links/consolidates other audit areas together via a formal
valuation in order to test whether shareholder value will be added.
The relevant areas of concern may include the financial, legal, labor, tax, IT, environment
and market/commercial situation of the company. Other areas include intellectual
property, real and personal property, insurance and liability coverage, debt instrument
review, employee benefits (including the Affordable Care Act) and labor matters,
immigration, and international transactions. Areas of focus in due diligence continue to
develop with cybersecurity emerging as an area of concern for business acquirers. Due
diligence findings impact a number of aspects of the transaction including the purchase
price, the representations and warranties negotiated in the transaction agreement, and the
indemnification provided by the sellers.

Due Diligence has emerged as a separate profession for accounting and auditing experts.

FOREIGN CORRUPT PRACTICE ACT.

With the number and size of penalties increasing, the Foreign Corrupt Practices Act
(FCPA) is causing many U.S. institutions to look into how they evaluate all of their
relationships overseas. The lack of a due diligence of a company’s agents, vendors, and
suppliers, as well as merger and acquisition partners in foreign countries could lead to
doing business with an organization linked to a foreign official or state owned enterprises
and their executives. This link could be perceived as leading to the bribing of the foreign
officials and as a result lead to noncompliance with the FCPA. Due diligence in regard to
FCPA compliance is required in two aspects:

Initial due diligence – this step is necessary in evaluating what risk is involved in
doing business with an entity prior to establishing a relationship and assesses risk at that
point in time.

Ongoing due diligence – this is the process of periodically evaluating each

relationship overseas to find links between current business relationships overseas and
ties to a foreign official or illicit activities linked to corruption. This process will be
performed indefinitely as long as a relationship exists, and usually involves comparing
the companies and executives to a database of foreign officials. This process should be
performed on all relationships regardless of location and is often part of a wider Integrity
Management initiative .[not in citation given]

In the M&A context, buyers can use the due diligence phase to integrate a target into their
internal FCPA controls, focusing initial efforts on necessary revisions to the target's
business activities with a high-risk of corruption.

While financial institutions are among the most aggressive in defining FCPA best
practices, manufacturing, retailing and energy industries are highly active in managing
FCPA compliance programs.

HUMAN RIGHTS.

Passed on May 25, 2011, the OECD member countries agreed to revise their guidelines
promoting tougher standards of corporate behavior, including human rights. As part of
this new definition, they utilized a new aspect of due diligence that requires a corporation
to investigate third party partners for potential abuse of human rights.

In the OECD Guidelines for Multinational Enterprises document, it is stated that all
members will “Seek ways to prevent or mitigate adverse human rights impacts that are
directly linked to their business operations, products or services by a business
relationship, even if they do not contribute to those impacts”.

The term was originally put forth by UN Special Representative for Human Rights and
Business John Ruggie, who uses it as an umbrella to cover the steps and processes by
which a company understands, monitors and mitigates its human rights impacts. Human
Rights Impact Assessment is a component of this.

The UN formalized guidelines for Human Rights Due Diligence on June 16 with the
endorsement of Ruggie’s Guiding Principles for Business and Human Rights.

CIVIL LITIGATION.

Due diligence in civil procedure is the idea that reasonable investigation is necessary
before certain kinds of relief are requested.

For example, duly diligent efforts to locate and/or serve a party with civil process is
frequently a requirement for a party seeking to use means other than personal service to
obtain jurisdiction over a party. Similarly, in areas of the law such as bankruptcy, an
attorney representing someone filing a bankruptcy petition must engage in due diligence
to determine that the representations made in the bankruptcy petition are factually
accurate. Due diligence is also generally prerequisite to a request for relief in states where
civil litigants are permitted to conduct pre-litigation discovery of facts necessary to
determine whether or not a party has a factual basis for a cause of action.

In civil actions seeking a foreclosure or seizure of property, a party requesting this relief
is frequently required to engage in due diligence to determine who may claim an interest
in the property by reviewing public records concerning the property and sometimes by a
physical inspection of the property that would reveal a possible interest in the property of
a tenant or other person.

Due diligence is also a concept found in the civil litigation concept of a statute of
limitations. Frequently, a statute of limitations begins to run against a plaintiff when that
plaintiff knew or should have known had that plaintiff investigated the matter with due
diligence that the plaintiff had a claim against a defendant. In this context, the term “due
diligence” determines the scope of a party’s constructive knowledge, upon receiving
notice of facts sufficient to constitute “inquiry notice” that alerts a would-be plaintiff that
further investigation might reveal a cause of action.

CRIMINAL LAW.

In criminal law, due diligence is the only available defense to a crime that is one of strict
liability (i.e., a crime that only requires an actus reus and no mens rea). Once the criminal
offence is proven, the defendant must prove on balance that they did everything possible
to prevent the act from happening. It is not enough that they took the normal standard of
care in their industry – they must show that they took every reasonable precaution.

Due diligence is also used in criminal law to describe the scope of the duty of a
prosecutor, to take efforts to turn over potentially exculpatory evidence, to (accused)
criminal defendants.
In criminal law, “due diligence” also identifies the standard a prosecuting entity must
satisfy in pursuing an action against a defendant, especially with regard to the provision
of the Federal and State Constitutional and statutory right to a speedy trial or to have a
warrant or detainer served in an action. In cases where a defendant is in any type of
custodial situation where their freedom is constrained, it is solely the prosecuting entities
duty to ensure the provision of such rights and present the citizen before the court with
jurisdiction. This also applies where the respective judicial system and/or prosecuting
entity has current address or contact information on the named party and said party has
made no attempt to evade notice of the prosecution of the action.

DUE DILIGENCE IN INDIA.

India presents a complex economic, regulatory, and legal landscape for doing business.
Consequently, the success of a business venture in India is dependent on a company’s
ability to traverse the Indian business landscape. A company’s success is in turn linked to
the risk management and mitigation strategy that it undertakes. It is in this regard that due
diligence becomes a powerful tool that companies may utilize when dealing with Indian
businesses. Due diligence ensures that a company is able to manage the risk prior to
entering into a business transaction.

Companies should conduct due diligence primarily for two reasons:

1.A company that plans to trade with an Indian company should verify that the business is
what it appears to be. This is vital in India, where several companies sprout up every day
with the sole motive of duping prospective clients and businesses. For example, in April
2016,pretend chit-fund companies (institutions which promote low interest rates and lend
money for houses and other purchases) were found to have cheated depositors out of U.S
12.2 billion (Rs 800 billion). This indicates a mala fide intent in the transaction, and
while such cases might be easier to identify in the preliminary stages of due diligence,
some scenarios require more in-depth exploration of the business.

2.The scenarios that require extended due diligence include identifying potential deal
destroyers”. This involves studying Indian companies’ financial health, including their
track record of bin payment their creditworthiness, and their standards of
compartmentalization and international regulatory and statutory requirements. Due
diligence of this nature is particularly important in India, where the tax regime is
extremely fragmented and companies often deal with business entitles from other states
within India that have different payment norms and taxes.

A company that wants to collaborate with an Indian company often needs to perform
extensive due diligence in comparison to trading with one. The nature of the transaction
while trading, including selling and purchasing goods and services, acts as an inherent
check on the risks. This requires that a foreign company undertake all aspects of due
diligence required for trading with Indian companies, such as a thorough assessment of
legal scope to check compatibility. In addition, companies should procure information
that aids in the valuation of assets and in negotiating price concessions. Finally, the due
diligence should verify that the proposed business transaction complies with the
mandated investment and acquisition criteria.

The process of conducting due diligence in different countries differs significantly,

though they seek to achieve very similar ends.

Independent reports note that countries that are more developed on average tend to have
less corruption and more transparency, which makes it easier to verify information that is
found. In turn, the presence of multiple government offices, which also act as public
offices of records, make information easily accessible to a business that wishes to
conduct due diligence. However, another factor that intricately linked to the accessibility
of information is the efficiency of such offices in maintaining information records. This is
dependent on the archiving and filing processes that such offices follow, as well as the
level information of records that they have undertaken. Developed countries often have
an excellent record of accomplishment on the aforementioned parameters as they have
access to superior IT Infrastructure. However, pushing towards digitization with
government initiatives such as ‘Digital India’ will help India close the gap in terms of
procuring and providing vital information digitally.

Reasons for conducting due diligence

When trading with an Indian company

·1 Verification that the business is what it appears to be

·2 Identify potential “deal destroyer” defects in the target and avoid a bad business
transaction

·3 Track records in paying bills, credit-worthiness and supplier worthiness

When partnering with an Indian company

·4 Same as above, but also including:

·5 Examination of legal scope for compatibility purposes

·6 Gain information that will be useful for valuing assets, defining representations
and warranties, and/or negotiating price concessions

·7 Verification that the transaction complies with investment or acquisition criteria.

Procedures regarding due diligence

There are two ways of conducting due diligence

·8 Presentation of predetermined data by the seller/target company in a ‘data room’.

·9 Data provided in response to the acquirer’s questionnaire.

Challenges in conducting due diligence

Due diligence does have hurdles like:

·10 Insufficiency of basic data; this makes going tough

·11 Road-blocks to obtaining or sharing proprietary information; and

·12 Confidentiality/secrecy covenants may prevent disclosure of material documents.

Benefits of professional due diligence

The benefits of a professional due diligence exercise include:

·13 Accuracy of warranties and representations;

·14 A ‘big picture’ of the vision of the target company and its future earnings;

·15 Complete analysis of the target company;

·16 Identification of deal-breaking issues and formulating business solutions to

resolve them; and

·17 Smooth transition of the merger.

How to get the best result from due diligence exercise

To ensure best results there are certain steps that should be taken into consideration:

·18 Clearly, define the objective make firm and clear strategies;

·19 Form groups of personnel for project management, data management, core due
diligence team and support team;

·20 Lay down the terms of reference for each group and formulate procedures for a
clear allocation of responsibilities;

·21 Observe an integrated approach for the due diligence process and rely on
technical consultants’ expertise wherever necessary;

·22 Use appropriate technology for the collection, analysis, indexing and retrieval of
data;

·23 Store the data in electronic form which makes it portable, capable of being
transferred to and accessed from remote locations, and providing a single point
access to the entire transaction team;

·24 Never hesitate to ask questions or seek clarifications;

·25 Always insist on plant visits – the on-site conditions contain a wealth of
information which would be never be available on paper;
 ·26 Due diligence should be continued until after the transaction is completed; and

·27 Take media reports in stride, do not value them too much nor ignore them.

SAMPLE OF DUE DILIGENCE CHECKLIST.

CONDUCTING DUE DILIGENCE.

When buying an established business it is vital that you, the prospective business owner,
examine the business in detail. This process is known as due diligence. Due diligence is
generally conducted after the buyer and seller have agreed in principle to a deal, but
before a binding contract is signed.

Conducting due diligence is the best way for you to assess the value of a business and the
risks associated with buying it. Due diligence gives you access to important and
confidential information about a business, often within a time period specified in a letter
of intent.

With this information you can assess the business's financial position and identify risks
and ongoing potential. It is your chance to answer any questions you might have about
the business. The due diligence process ensures that you get good value for a business.
Done correctly, it can be the difference between buying a business that makes you money
and buying a business that costs you money.

You should always perform due diligence with the help of your lawyer, accountant or
business adviser.

Investigating a business

To conduct due diligence you'll need to carefully review:

·28 income statements
·29 records of accounts receivable and payable
·30 balance sheets and tax returns including business activity statements (last 3-5
years)
·31 profit and loss records (last 2-3 years)
·32 cash deposit and payment records, as reconciled with the accounts
·33 utility accounts
·34 bank loans and lines or letters of credit
·35 minutes of directors' meetings/management meetings
·36 audit work paper files (if available)
·37 the seller's claims about their business (e.g. their reasons for selling, the business's
reputation)
·38 privacy details (e.g. of employees, trading partners, customers)
·39 stock
·40 details about plant, equipment, fixtures, vehicles (are they in good working order
and licensed?)
 ·41 intellectual assets of the business (e.g. intellectual property, trademarks, patents)
·42 existing contracts with clients/staff
·43 partnership agreements
·44 lease arrangements
·45 details of the business's automated financial systems
·46 details of credit and historical searches related to the business.
You also need to value the business to check whether the asking price is fair.

PROCESS OF DUE DILIGENCE.

Below are detailed steps for individual investors undertaking due diligence. Most are
related to equities, but aspects of these considerations can apply to debt instruments, real
estate and other investments as well.

Step 1: Analyze the Capitalization (Total Value) of the Company

The first step: determine just how big the company is. The company’s market
capitalization says a lot about how volatile the stock is likely to be, how broad the
ownership might be and the potential size of the company's end markets. For example,
large cap and mega cap companies tend to have more stable revenue streams and a large
more diverse investor base, both of which generally equate to less volatility. Mid cap and
small cap companies, meanwhile, may only serve single areas of the market, and may
have more fluctuations in their stock price and earnings. When you start to examine
revenue and profit figures, the market cap will give you some perspective.
Conversely, the largest, most expensive real estate in any market is generally less liquid
than more average-priced properties.
You should also confirm one other vital fact on this first check: What stock exchange do
the shares trade on? Are they based in the United States (such as the New York Stock
Exchange, Nasdaq, or over the counter)? Or, are they American depositary receipts
(ADRs) with another listing on a foreign exchange? ADRs will typically have the letters
"ADR" written somewhere in the reported title of the share listing. This information
along with market cap should help answer basic questions like whether you can own the
shares in your current investment accounts.

Step 2: Revenue, Profit, and Margin Trends

When beginning to look at the numbers, it may be best to start with the revenue and profit
margin (RPM) trends. Understanding a company's gross revenue, profit margins and
return on equity and whether it is growing or shrinking is essential in any equity or
corporate bond investment.
Look up the revenue and net income trends for the past two years at a general finance
website. These should have links to quarterly (for the past 12 months) and annual reports
(past two to three years). Look at the recent trends in both sets of figures, noting whether
growth is choppy or consistent, or if there any major swings (such as more than 50% in
one year) in either direction.
Profit margins should also be reviewed to see if they are generally rising, falling, or
remaining the same. Some investors demand that a company's return on equity plus its
profit margins be equal to 50 or greater – the higher the better. This information will
come into play more during the next step.

Step 3: Competitors and Industries

Now that you have a feel for how big the company is and how much money it earns, it's
time to size up the industries it operates in and who it competes with. Every company is
partially defined by its competition. Compare the margins of two or three competitors.
Looking at the major competitors in each line of business (if there is more than one) may
help you nail down just how big the end markets for products are. Is the company a
leader in its industry? Is its industry growing overall, and could its position in the field
change?
Information about competitors can be found in company profiles on most major research
sites, usually along with a list of certain metrics filled in for both the company you're
researching and its competitors. If you're still uncertain of how the company's business
model works, you should look to fill in any gaps here before moving further along.
Sometimes just reading about some of the competitors may help to understand what your
target company does.

Step 4: Valuation Multiples

Now it's time to get to the nitty-gritty of price-to-earnings (P/E) ratio, price/earnings to
growth (PEGs) ratio and price-to-sales (P/S) ratio and the like, for both the company and
its competitors. Note any large discrepancies between competitors for further review. It's
not uncommon to become more interested in a competitor during this step, but still look
to follow through with the original pick.
P/E ratios can form the initial basis for looking at valuations. While earnings can and will
have some volatility (even at the most stable companies), valuations based on trailing
earnings or on current estimates are a yardstick that allows instant comparison to broad
market multiples or direct competitors. Basic "growth stock" versus "value stock"
distinctions can be made here, along with a general sense of how much expectation is
built into the company. It's generally a good idea to examine a few years' worth of net
earnings figures to make sure most recent number (and the one used to calculate the P/E)
is normalized, and not being thrown off by a significant one-time charge or adjustment.
Investors in real estate sometimes examine the cost to replace a building as compared to
the value of the entire property.
Not to be used in isolation, the P/E should be looked at in conjunction with the price-to-
book (P/B) ratio, the enterprise multiple, and the price-to-sales (or revenue) ratio. These
multiples highlight the valuation of the company as it relates to its debt, annual revenues,
and balance sheet. Because ranges in these values differ from industry to industry,
reviewing the same figures for some competitors or peers is a critical step.
Finally, the PEG ratio brings into account the expectations for future earnings growth,
and how it compares to the current earnings multiple. In some areas this ratio may be less
than one, while in others it may be as much as 10 or higher. Stocks with PEG ratios close
to one are considered fairly valued under normal market conditions.
Step 5: Management and Share Ownership
Is the company still run by its founders? Or has management and the board shuffled in a
lot of new faces? The age of the company is a big factor here, as younger companies tend
to have more of the founding members still around. Look at consolidated bios of top
managers to see what kind of broad experiences they have; this information may be found
on the company's website or on SEC filings.
Also look to see if founders and managers hold a high proportion of shares, and what
amount of the float is held by institutions. Institutional ownership percentages indicate
how much analyst coverage the company is getting, as well as factors influencing trade
volumes. Consider high personal ownership by top managers as a plus, and low
ownership a potential red flag. Shareholders tend to be best served when the people
running the company have a vested interest in the performance of the stock.

Step 6: Balance Sheet Exam

Many articles could easily be devoted to just the balance sheet, but for our initial due
diligence purposes, a cursory exam will do. Look up a consolidated balance sheet to see
the overall level of assets and liabilities, paying special attention to cash levels (the
ability to pay short-term liabilities) and the amount of long-term debt held by the
company. A lot of debt is not necessarily a bad thing, especially depending on the
company's business model. But what are agency ratings for its corporate bonds? And
does the company generate enough cash to service its debt and pay any dividends? Some
companies (and industries as a whole) are very capital intensive, while others require
little more than the basics of employees, equipment, and a novel idea to get up and
running. Look at the debt-to-equity ratio to see how much positive equity the company
has going for it; you can then compare this with the competitors to put the metric into
better perspective. In general, the more cash a company generates, the better an
investment it's likely to be.
If the "top line" balance sheet figures of total assets, total liabilities and stockholders'
equity change substantially from one year to the next, try to determine why. Reading the
footnotes that accompany the financial statements and the management's discussion in the
quarterly/annual report can shed some light on the situation. The company could be
preparing for a new product launch, accumulating retained earnings or simply whittling
away at precious capital resources. What you see should start to have some deeper
perspective after having reviewed the recent profit trends.

Step 7: Stock Price History

At this point, you'll want to nail down just how long all classes of shares have been
trading, and both short-term and long-term price movement. Has the stock price been
choppy and volatile, or smooth and steady? What was the price three and six months and
one, two, three, five and 10 years ago? Is it rising or falling? Does this history match its
profit trends? All this outlines what kind of profit experience the average owner of the
stock has seen, which can influence future stock movement. Stocks that are continuously
volatile tend to have short-term shareholders, which can add extra risk factors to certain
investors.

Step 8: Stock Options and Dilution Possibilities

Next, investors will need to dig into the 10-Q and 10-K reports. Quarterly SEC filings are
required to show all outstanding stock options as well as the conversion expectations
given a range of future stock prices. Use this to help understand how the share count
could change under different price scenarios. Are there any insider lock-up expirations on
the horizon? Is it conceivable that the company may complete a secondary offering?
While employee stock options are potentially a powerful motivator, watch out for shady
practices like re-issuing of underwater options or any formal investigations that have
been made into illegal practices like options backdating. With real estate, look to see if
there is any inventory that could be brought to market nearby?

Step 9: Expectations
This is a sort of a catch-all, and requires some extra digging. Investors should find out
what the consensus of Wall Street analysts for earnings growth, revenue and profit
estimates are for the next two to three years. For real estate, what is the opinion of
professionals regarding future price trends and interest rates? Investors should also
research discussions of long-term trends affecting the industry and company-specific
details about partnerships, joint ventures, intellectual property, and new
products/services. News about a product or service on the horizon may be what initially
turned you on to the stock, and now is the time to examine it more fully with the help of
everything you've accumulated thus far.

Step 10: Examine Long and Short-term Risks

Setting this vital piece aside for the end makes sure that we're always emphasizing the
risks inherent with investing. Make sure to understand both industry-wide risks and
company-specific ones. Are there outstanding legal or regulatory matters, or just a spotty
history with management? Is the company eco-friendly? And, what kind of long-term
risks could result from it embracing/not embracing green initiatives? Investors should
keep a healthy game of outcomes on the stock.
What is the worst case scenario? If a new product fails or a competitor brings a new and
better product forward, how would this affect the company? How does an investing plan
manage downside risk? For real estate, how would a jump in interest rates affect the
ability to carry a mortgage on a property?
Once you've completed these steps, you should be able to wrap your mind around what
the company has done so far, and how it might fit into a broad portfolio or investment
strategy. Inevitably you'll have specifics that you will want to research further, but
following these guidelines should save you from missing something that could be vital to
your decision.

AREAS OF DUE DILIGENCE.

The due diligence process is applied in two basic business situations: 1) transactions
involving sale and purchase of products or services, and 2) transactions involving
mergers, acquisitions, and partnerships of corporate entities. In the former instance,
purchase and sales agreements include a series of exhibits that, taken in their entirety,
form due diligence of the purchase. These include actual sales contracts, rental contracts,
employment contracts, inventory lists, customer lists, and equipment lists. These various
"representations" and "warranties" are presented to back up the financial claims of both
the buyer and seller. The importance of this kind of due diligence has been heightened in
recent years with the emergence of the Internet and other transformative technologies.
Indeed, due diligence is a vital tool when a company is confronted with major purchasing
decisions in the realm of information technology. "A due diligence investigation should
answer pertinent questions such as whether an application is too bulky to run on the
mobile devices the marketing plan calls for or whether customers are right when they
complain about a lack of scalability for a high-end system," said Copeland.
In cases of potential mergers and acquisitions, due diligence is a more comprehensive
undertaking. "The track track record of past operations and the future prospects of the
company are needed to know where the company has been and where its potential may
carry it," explained William Leonard in Ohio CPA Journal. In addition, observers note
that the dramatic increase in information technology (IT) in recent years has complicated
the task of due diligence for many companies, especially those engaged in negotiations to
buy or merge with another company. After all, system incompabilities can require huge
amounts of time, money, and personnel resources to integrate.
Leonard notes that traditional due diligence practices in acquisition/merger scenarios
called for detailed examination of financial statements, accounts receivable, inventories,
workers compensation, employment practices and employee benefits, pending and
potential litigation, tax situation, and intellectual property prior to signing on the dotted
line. But in this dynamic business era, other areas should be looked at as well, including
(if applicable): intellectual property rights, new products in the production pipeline, status
of self-funded insurance programs, compliance with pertinent ordinances and regulations,
competition, environmental practices, and background of key executives/personnel.
Many business experts also caution that the due diligence process is incomplete if it does
not incorporate an element of objective self-analysis. "Self-analysis is the fundamental
first step to realistically determine whether the post-acquisition 'whole' will be greater
than the sum of its part," wrote Aaron Lebedow in Journal of Business Strategy. A
detailed assessment of the market that is the target of the proposed acquisition should also
be undertaken prior to closing a deal. Both of these requirements can be completed in a
reasonable period of time, even in today's fast-changing business environment, by
companies that either 1) outsource the due diligence task to a reputable research firm or
2) build an efficient in-house program within their legal, marketing, or corporate security
sectors. "Unquestionably, opportunities for growth through acquisition exist," stated
Lebedow. "Exploiting these opportunities has risks, but to those companies that acquire
only after a comprehensive and systemic assessment of the marketplace and competition,
the rewards justify the risks. Limiting due diligence to financial and managerial review is
rarely enough. Successful acquisition strategy depends on the structure and depth of the
due diligence process."

WHO NEED DUE DILIGENCE SERVICES?

Well, it is depend. Why we say this? Imagine, Due Diligence Services require at the time
one company is being targeted by another and those prospective owner are interested in.
So it simply mean at the time of negotiation.
So at the time of negotiation, it is dependence on the result of negotiation. Sometime, the
potential investors are the one who require this services and they are the one who the
accounting firm engaged with. However, sometime the targeting company want to show
it transparency on the business transaction with it partners, the engagement is initiate by
them with accounting firm.
Related article Audit evidences: Definition, Types, Procedures, and Quality
But, based on experiences, the result of most of negotiation of acquisition, the targeted
company is the one who engaged with accounting firm and the one who mandatory need
such kind of services are the potential investors as the benefits are run to them rather than
the targeted company.

WHO PROVIDE DUE DILIGENCE SERVICES?

Well, Due Diligent service is one of the most popular services among assurance and non
assurance service. Such kind of service provided by accounting firms.
The big four audit firms are normally dominate not only audit services, also Due
Diligent.Those Big Four Audit Firm included.They are Firms that provide Due Diligence
Service:
·47 PWC
·48 KPMG
·49 EY
 ·50 DELOITTE
These firm normally have the expert and long term experiences staff to provide suck kind
of service.
To get the expert report, theses big four audit firm are what we recommended for.

ADVANTAGE OF DUE DILIGENCE

·51 Verification of accounts
·52 Verification of information
·53 To know the market position
·54 To know the financial position
·55 To provide opportunity to seller
·56 Increase number of shareholders
·57 True and fair position of the business
 DISADVANTAGES OF DUE DILIGENCE.
·58 Lack of accuracy
·59 Time consuming process
·60 Undisclosed information

BUY-SIDE DUE DILIGENCE SERVICES.

Determine whether the deal is right for you.
Your goal is to make the right acquisition for the right price — you don't want buyer's
remorse.
That's exactly why the buy-side due diligence process is so important. Rigorous,
objective due diligence methodology allows us to analyze and validate financial,
operational and strategic aspects of the deal, making it easier for you to structure and
negotiate a favorable deal.
Our pre- and post-transaction buy-side due diligence services help reveal risks and
opportunities so you can make an informed decision about how and whether to
proceed. We'll help you:
·61 Assess the target's earnings and cash-flow quality
·62 Analyze the quality of assets and liabilities being acquired or assumed
·63 Evaluate the quality of working capital and recent trends
·64 Identify internal control weaknesses of systems and personnel
·65 Provide additional insights on the target's financial projection analyses
·66 Assist with review of the purchase agreement and much more

SELL-SIDE DUE DILIGENCE SERVICES.

Don’t risk a broken deal — address issues before you have a buyer Sell-side due
diligence could increase your buyer's trust level and willingness to pay top dollar. But
your staff may not have enough time or experience to identify and explore potential
issues. And, they may not know how those issues could affect the deal's outcome. An
investment in professional pre-sale due diligence will produce accurate financial
information for your buyer and also address operational, technology and human resource
issues that could be the difference between a successful sale and a long, potentially
contentious transaction process. This is particularly true today, where due diligence
efforts have intensified and buyer-identified issues can place a seller in a defensive
negotiating position on price and transaction terms.
Benefits of sell-side due diligence
The potential benefits of sell-side due diligence include:
·67 Collaborating with investment bankers to address risks early, accelerating time to
close
·68 Improving the accuracy of the historical and projected financial information
contained in the marketing materials
·69 Providing the buyer with a transparent, objective and credible view of the
business
·70 Minimizing surprises and maximizing transaction value by adding credibility and
objectivity to the process, especially where there has been no financial audit
·71 Identifying adjustments that positively impact EBITDA (typically, potential
acquirers only inform sellers about negative adjustments)
·72 Augmenting your internal management resources with the experienced resources
you need to complete the transaction
·73 Increasing competition between buyers and minimizing buyer negotiations after
the letter of intent
·74 Maximizing after-tax proceeds by addressing risks and optimizing the deal
structure

TYPES OF DUE DILIGENCE SERVICES.

There are three types of due diligence
1. LEGAL DUE DILIGENCE:
Legal due diligence seeks to examine the legal basis of a transaction, for example to
ensure that a target business holds or can exercise the intellectual property rights that are
crucial to the future success of the company.
Other areas that would most likely be explored include:
·75 Legal structure
 ·76 Contracts
·77 Loans
·78 Property
·79 Employment
·80 Pending litigation.
2. FINANCIAL DUE DILIGENCE:
Financial due diligence focuses on verifying the financial information provided and to
assess the underlying performance of the business.
This would be expected to consider areas such as:
·81 Earnings
·82 Assets
·83 Liabilities
·84 Cash flow
·85 Debt
·86 Management
3. COMMERCIAL DUE DILIGENCE:
Commercial due diligence considers the market in which a business sits, for example
involving conversations with customers, an assessment of competitors and a fuller
analysis of the assumptions that lie behind the business plan. All of this is intended to
determine whether the business plan stands up to the realities of the market.
4. OTHER:
Other types of due diligence cover areas such as taxation, pensions, IT systems and
intellectual property
 SWOT ANALYSIS

WHAT’S A SWOT ANALYSIS?

It’s a sound business tool that’s used to highlight the key issues and features of a
business, and the environment it operates in. A SWOT analysis gives you a focus for
areas you need to concentrate on. It’s part of your strategic analysis.
A SWOT analysis gets you to ask FOUR questions. What are they:
• Key Strengths of this business?
• Key Weaknesses of this business?
• Main Opportunities for this business?
• Main Threats to this business?
Strengths and Weaknesses relate to the business itself.Opportunities and Threats can also
refer to issues outside the business.
STRENGTHS:
• What are the key products or services sold?
• What does this business do well?
• What key skills and capabilities are held within the business?
• What are the things this business has going for it?
• What is its USP – it’s Unique Selling Proposition?
• What is the business’s reputation?
WEAKNESSES:
• What are the areas the business may struggle in?
• What aspects of the business don’t appear right, or don’t make sense?
• What needs attention?
• What can be improved on?
OPPORTUNITIES:
• Where can you go with this business if you make some changes?
How can you put your own personality into it?
• What new products and services you can add or develop?
• What can you do to improve performance?
• What efficiencies can you gain with the current systems/
processes?
• What can you do that is not being done now?
THREATS:
• What are the issues that could threaten the business’s fi nancial
situation?
• What are the signifi cant changes in this industry that could occur?
• What is changing in the wider marketplace?
• What are the competitors doing, who are they and where are
they?
A careful SWOT analysis will alert you to important issues to consider during your due
diligence phase of checking the business with eyes wide open before you fully commit to
buying it. Remember that “a business which fails to plan, plans to fail”

DUE DILIGENCE AND RISK MANAGEMENT.

Due diligence is the effort made by an ordinarily prudent or reasonable person to prevent
harm to another person or the environment hazard is a situation which could lead to harm
consequence is the outcome of the hazard occurring (risk event); there can be more than
one consequence from one event probability is the extent to which the hazard is likely to
occur risk is a combination of the severity and likelihood of harm arising from a hazard
[ Risk = Probability X Consequence] risk assessment is the process of identifying,
estimating and evaluating risk. risk management is the process of identifying and
analyzing risk and deciding on appropriate course of action to avoid or minimize the risks
risk control is the process of identifying, implementing and monitoring measures to
reduce the risk associated with a hazard that now includes not only principles and
guidance related to environmental stewardship, but also to social responsibility, as well as
health and safety Due diligence can be thought of as the effort one would expect a
reasonably prudent person to exercise in similar circumstances to prevent harm. The key
to the concept of due diligence is the foreseeability of the risk. If the risk can reasonably
be foreseen, then steps must be taken to address it. Essentially, due diligence is a risk
management process; therefore, the terms risk management and project due diligence are
used interchangeably in this guidance. Risk management can be described as all the
activities performed to identify, assess and control the uncertainties which may impact on
an exploration project’s ability to achieve its aims, objectives and opportunities. As
previously stated, project due diligence is a risk based decision and planning exercise,
designed to enable you to decide if you should proceed with a project and, if so, how to
do so in a way that enables you to manage the social, economic and environmental risks.
Project due diligence is not mandated by legislation; it is a voluntary management tool
that is part of a prudent risk management strategy.
Project due diligence involves two interrelated risk management objectives:
(1)to avoid or minimize risk to the project;
(2) to prevent harm to people and the environment.

WHAT IS THE RELATIONSHIP BETWEEN DUE

DILIGENCE AND IMPACT ASSESSMENT?
Project due diligence and social and environmental impact assessment are related
exercises and share the same ultimate goal – preventing harm to people and the
environment. Impact assessment also involves elements of both risk assessment and risk
management. However, while social and environmental impact assessments can be
undertaken voluntarily, in most countries they are typically mandated by legislation, as
part of regulatory approval for large development projects. Impact assessment is a means
to ensure that regulatory decision-makers have sufficient information on the social and
environmental impacts of a project to decide if it should be allowed to proceed. Impact
assessment is the assessment of the possible social and/or environmental impacts –
positive or negative – of a proposed project or action. The main difference between
impact assessment and project due diligence is that impact assessment typically involves
more detailed studies of the natural and/or social environment, to provide the context for
assessing the impact of a proposed activity. Impact assessment uses data on baseline
conditions and compares it to the anticipated impacts and the strategies proposed to
minimize impacts, to determine whether the impacts of a project as proposed are
acceptable.
Impact assessment is not typically necessary at early stages of exploration. In the latter
stages of exploration, however, as the prospect of a mine begins to crystallize and/or as
the scope and scale of exploration activities expand, explorers may be required by law to
conduct impact assessments, or it may be prudent to voluntarily undertake more detailed
impact assessment studies, to support project due diligence.

WHAT IS RISK MANAGEMENT?

Risk management involves two main components:
(1) risk assessment, which
is the identification and evaluation of the risk of a given decision or activity; and
(2) risk control, which involves the identification of controls (strategies and
processes) to reduce the risk and the implementation, monitoring and review of
those strategies.
Each of the two components involves a series of activities that vary in number,
depending on the risk management methodology. For the purposes of project due
diligence, a streamlined, straight forward risk management process works best.

DUE DILIGENCE BASICS FOR STARTUP INVESTMENT.

When considering investing in a startup, follow the above-mentioned steps (where
applicable). But here are some startup-specific moves, reflecting the high level of risk
this sort of enterprise carries.
Include an exit strategy: More than 50% of startups fail within the first two years.
Plan your divestment strategy to recover your funds should the business fail.
Consider entering into a partnership: Partners split the capital and risk among
themselves. Thus, there is a lower risk, and you lose fewer resources should the business
fail in the first few years.
Figure out the harvest strategy for your investment : Promising businesses
may fail due to a change in technology, government policy or the market. Be on the
lookout for new trends, technologies and brands, and harvest when you find that the
business may not thrive with the introduction of new factors in the market.
Choose a startup with promising products: Since most investments are
harvested after five years, it is advisable to invest in products that have an increasing
return on investment (ROI) for that period. Furthermore, look at the growth plan of the
business, and evaluate whether it is viable.

MERGER ACQUISITION DUE DILIGENCE.

Due diligence is a vital activity in M&A transactions, and may consume several months
of intense analysis if the target firm is a large business with a global presence. Using a
variety of methods and accepted principles, the due diligence team pursues an answer to
the question: “Do we buy–and if so–how do we structure the transaction and how much
do we pay?” To answer this question, M&A due diligence activities typically focus on
four areas at a target firm:
·87 Strategic Position
·88 Financial Data
·89 Operational Assets
·90 Legal Matters
Each of these four areas can be further sub-divided into business, legal, and functional
areas–including IT–each receiving the appropriate level of attention and analysis based
upon the category and nature of the deal.
Conducting M&A due diligence in today’s global marketplace is a demanding, high-
pressure undertaking that requires considerable skill and expertise. As a result, firms that
do a lot of M&A transactions often develop their own in-house M&A due diligence
expertise, whereas firms that pursue occasional M&A transactions often engage outside
professionals to assist them with this highly complex and risky activity.

SOFT AND HARD DUE DILIGENCE.

One fairly recent development in the mergers and acquisitions (M&A) world is the
delineation between "hard" and "soft" forms of due diligence. In traditional M&A
activity, an acquiring firm deploys risk analysts who perform due diligence by studying
costs, benefits, structures, assets and liabilities, etc. This is colloquially known as hard
due diligence. Increasingly, however, M&A deals are also subject to the study of a
company's culture, management and other human elements, otherwise known as soft due
diligence. Hard due diligence, which is driven by mathematics and legalities, is
susceptible to rosy interpretations by eager salespeople. Soft due diligence acts as a
counterbalance when the numbers are being manipulated – or overemphasized.
It is easy to quantify organizational data, so in planning acquisitions, corporations
traditionally focused on the hard numbers. But the fact remains there are many drivers of
business success that numbers cannot fully capture, such as employee relationships,
corporate culture and leadership. When M&A deals fail, as more than 50% of them do, it
is often because the human element is ignored. For example, one set of a productive
workforce may do very well under existing leadership, but might suddenly struggle with
an unfamiliar management style. Without soft due diligence, the acquiring company does
not know if the target's firms employees will resent the fact they are bearing the brunt of
a corporate cultural shift.
Contemporary business analysis calls this element "human capital." The corporate world
starting taking notice of its significance in the mid-2000s. In 2007, the Harvard Business
Review dedicated part of its April Issue to what it called "human capital due diligence,"
warning that companies ignore it at their peril.

PERFORMING HARD DUE DILIGENCE.

In an M&A deal, hard due diligence is often the battlefield of lawyers, accountants and
negotiators – an investigation by the acquiring firm to confirm it is "buying what it thinks
it's buying," to quote Peter Howson, author of "Due Diligence: The Critical Stage in
Mergers and Acquisitions." Typically, hard due diligence focuses on earnings before
interest, taxes, depreciation and amortization (EBITDA), the aging of receivables and
payables, cash flow and capital expenditures. In sectors such as technology or
manufacturing, additional focus is placed on intellectual property and physical capital.
Other examples of hard due diligence activities include:
* Reviewing and auditing financial statements;
* Scrutinizing projections, normally the target's projections, about future performance;
* Consumer market analysis;
* Operating redundancies and ease of eliminating them;
* Potential or ongoing litigation;
* Review of antitrust considerations;
* Evaluating subcontractor and other third-party relationships;
* Constructing and executing a disclosure schedule.

PERFORMING SOFT DUE DILIGENCE.

Conducting soft due diligence is not an exact science. Some acquiring firms treat it very
formally, including it as an official stage of the pre-deal phase. Others are less targeted;
they might spend more time and effort on the human resources side, and have no defined
criteria for success.
Bain & Company, a leader in M&A support, emphasizes key employees during its soft
due diligence phase. The concept is simple: These key employees act as cultural support
structures and role models during a management transition, so the acquiring firm ought to
make them comfortable. If this basic step cannot be completed, it is probably a sign the
deal will struggle.
Soft due diligence should focus on how well a target workforce will mesh with the
acquiring corporation's culture. If the cultures do not seem like an ideal fit, concessions
might have to be made. This includes personnel decisions, particularly with top
executives and other influential employees.
There is at least one area where hard and soft due diligence intertwine:
compensation/incentives programs. These programs are not only based on real numbers,
making them easy to incorporate into post-acquisition planning; they can also be
discussed with key employees and used to gauge cultural impact. Soft due diligence is
concerned with employee motivations, and compensation packages are specifically
constructed to influence those motivations. It is not a panacea or a cure-all band-aid, but
soft due diligence can help the acquiring firm predict whether a compensation program
can be implemented to improve the success of a deal.
Soft due diligence can also concern itself with the target company's customers. Even if
the target employees accept the cultural and operational shifts from takeover, the target
customers and clients may well resent a change (actual or perceived) in service, products,
procedures or even names. This is why many M&A analyses now include customer
reviews, supplier reviews and test market data.

FINANCIAL DUE DILIGENCE.

THE IMPORTANCE AND PURPOSE OF FINANCIAL DUE
DILIGENCE.
Financial due diligence refers to financial professionals, according to the acquiring
party’s objectives and commissioned scope, conducting investigation into the target
firm’s financial circumstances and various other related factors. Financial due diligence
ordinarily employs methods such as document review, conducting discussion and
interviews with senior management and key employees, comparing historical financial
data and trend analysis, and finally the reporting of financial and tax risks along with the
actual operational situation of the target firm in written form to the acquiring party.
Conducting financial due diligence is not only related to proposed acquisitions or
mergers, it can also be directed against joint ventures, financing or other deals and
transactions. Principal work usually centres on people related or interest related business
activities and relevant financial data, the ultimate goal being to provide assistance to the
acquiring party in eliminating asymmetric information, and allowing the acquiring party
to obtain a greater depth of understanding with regards to the target firm. Due to the
differing characteristics of various industries, the knowledge and understanding of a
certain industry on the side of an acquiring party might also differ from an equitable level
with that of the target firm. Therefore financial due diligence process should be modified
or adjusted so as to meet the acquiring party’s specific needs and expectations. Generally
speaking, the most important usage of financial due diligence is to realise the following
functions:
Financial due diligence has the primary objective of establishing and understanding a
target firm’s actual financial situation in the recent few years (in most cases around three
years), and subsequently forecasting its future financial situation. This is the basis for the
acquiring party’s current valuation of the target firm. For strategic investment decisions,
as well as for providing a necessary foundation for formulating a post-acquisition
business plan and integration program, the target firm’s internal control and actual
situation of operational managements must be initially understood.
1.To sufficiently reveal financial and tax risks
2.To analyse a firm’s past profitability and cash flow, and according to this forecast the
firm’s future operational prospects
3.To understand the target firm’s assets and liabilities (including contingent liabilities),
internal control, and the actual situation of operations management, providing a suitable
foundation for follow-up negotiations, strategic investment decisions and the formulation
of a post-acquisition business plan and integration program.
4.When compiled wth other due diligence results such as legal and operational due
diligence, to determine whether the item of investment in question is in keeping with the
acquiring party’s general strategic targetsand investment principles.
Financial due diligence has the primary objective of establishing and understanding a
target firm’s actual financial situation in the recent few years (in most cases around three
years), and subsequently forecasting its future financial situation. This is the basis for the
acquiring party’s current valuation of the target firm. For strategic investment decisions,
as well as for providing a necessary foundation for formulating a post-acquisition
business plan and integration program, the target firm’s internal control and actual
situation of operational managements must be initially understood.

NEED FOR FINANCIAL DUE DILIGENCE.

Mostly sought for the following transactions:
1.Disinvestments
2.Strategic investments or a PE investment.
3.Acquisition of an undertaking / business.
4.Inbound and overseas investment.
5.Listing of securities in Indian or overseas market.

FUNDAMENTAL PRINCIPLES OF FINANCIAL DUE

 DILIGENCE
Even though financial due diligence differs from general audit work, staff participating in
a due diligence investigation, acting as third party independent financial consultants in
the merger and acquisition group, must adhere to the following principles:
1. Independence Principle - The independence principle typically covers two elements,
the first is that of the financial consultancy
firm, the second is the group of financial professionals that work on an investigation. For
instance, before the aforementioned financial consultancy firm accepts the engagement it
must not have provided the firm in question with any service that could possibly conflict
with that project of financial due diligence, and any financial professionals concerned
with the project must not hold any direct or indirect economic interest concerning the
firms involved, in order to guarantee said financial consultancy and project group
members’ independence.
- Upholding an objective approach, establishing that any determination should be devised
rationally and only according to already acquired and well understood information.
2. Prudence Principle
The prudence principle manifests itself in the following elements:
- Upholding a prudent and professionally skeptical approach, from beginning to end,
through the process of due diligence.
- Review of work plans, staff allocation, working papers and financial due diligence
report.
3. Comprehensiveness Principle
Financial due diligence should cover all aspects of the target firm’s relevant financial
management and accounting.
4. Materiality
In light of differing industries and differing firms, investigations must be conducted
according to levels of risk after sufficiently considering client requirements.

METHODS OF FINANCIAL DUE DILIGENCE.

During the investigative process, financial personnel usually will employ the following
fundamental methods:
Review - through review of financial statements and other financial materials, identify
critical and material financial factors;
Analytical procedures – includes procedures such as performance analysis, trend
analysis, structural analysis etc. analysis of materials acquired through all channelsthen
through collating the results of this analysis discovering abnormalities and important
issues.
Interview - sufficient communication with every level of the internal hierarchy,
employees of different positions and roles, as well as intermediary institutions.
Internal communication - due to investigative group personnel coming from different
backgrounds and specialisations, mutual communication and timely sharing of work
results creates an effective method of accomplishing investigative targets.
In this comparison we have indicated that there are some key differences in the objectives
of financial due diligence and financial statement auditing. In addition, the duration of a
financial due diligence is comparably short, and therefore in the place of auditing
methods such as confirmations, physical inventory observation and the re-calculation of
financial figures, methods such as trend analysis, structural analysis and other
suchanalytical tools are more often utilised.

CONTENTS OF FINANCIAL DUE DILIGENCE.

Usually the acquiring party will employ an independent third party intermediary
institution, typically a consulting firm or accountancy firm, to conduct financial due
diligence on the target firm.
Financial due diligence engagement can be divided into the four stages -
project preparation,
project planning,
project implementation
project completion.
1. Project Preparation Stage
The intermediary institution, before accepting the engagement, needs to carry out initial
operational activities and decide whether or not to accept the engagement. At the time of
carrying out these initial operations, the principal questions it must consider are:
First, the professional competence of personnel, ascertain whether or not the personnel
are familiar with the related industry and client, whether they possess experience of
carrying out similar engagements, whether they are equipped with the necessary technical
capacity and knowledge, and if the occasion requires whether they are capable of
obtaining specialist help.
Second, consider the objectives of the prospective clients, confirming that there are no
misunderstandings in the terms of the engagement. Due to the special features of merger
and acquisition projects, when accepting an engagement, the confidentiality agreement,
the usage of the report and terms of the disclaimer are all areas which warrant particular
emphasis and attention.
2. Project Planning Stage
(1) Initial Preparative Work
Includes explaining to the target firm the investigative objectives and the relationship
with the client, compiling and issuing an investigation data manifest, and understanding
the target firms historical evolution, organisational structure, primary operational scale,
ownership and investment structure, as well as future development tendency etc. At the
same time, estimating the target firm’s scale and degree of operations complexity, this
would facilitate the determination of project personnel, work progress and key areas to
focus on.
(2)Compiling an Investigative Plan
After the initial preparation of the investigation, the project leader ought to begin the
compilation of an overall work plan for the project. The project plan should comprise of
project objectives, investigation procedures, key areas to focus on during the
investigation, project personnel composition, project time and location arrangements etc.
At the same time, within the framework of the overall work plan, the project manager
should also compile and revise a detailed work program for the financial due diligence.
(3) Risk Assessment Procedures
In financial due diligence, the following elements constitute risk assessment:
a) The state of affairs in the industry, and the legal and regulatory environment, amongst
other external factors;
b) The nature of the target company;
c) The target company’s objectives, strategies and relevant operational risks;
d) The target company’s financial statements and primary financial issues.
3. Implementation Stage
(1) A few aspects that should be effectively grasped during investigative work:
a) Sustainable Operation
Operational cash flows are a useful indicator for understanding the sustainability of the
target company’s operational situation. In comparison to accounting profits that can be
subject to manipulation, cash flows can be more a more accurate representation of the
going concern of the target company. Furthermore, taking into account the target
company’s motives for accepting an acquisition, the difficulties it confronts relating to
sustainable operation can be observed.
b) Internal Control
Documents related to internal control should be obtained and read through, and a walk-
through test should be conducted, in an effort to understand and evaluate the rationality of
the internal control design and its effectiveness in execution.
c) Financial Affairs
Information about the accounting policies, financial structure, credit worthiness, asset
quality and
profitability of the target company need to be obtained. The admissive degree of the
target company’s financial standing is subject to the level of internal control, but
procedures involving important issues must be conducted in a thorough manner, for
instance the verification of the ownership of major assets and contingencies. For those
cases already highlighted, for example mortgages and guarantees, contingencies, pending
legal actions, etc. need to be followed up as they develop. For risk items not highlighted,
they should become the major focus of the financial due diligence work.
d) Taxation Affairs
The current structure of the tax burden, tax treatment, and the fulfilment of paying and
withholding tax in the target company should be studied. For enterprises enjoying tax
preference, one should estimate their tax burdens after the end of the preferential period;
for those who have not fulfilled their obligation to pay tax, one should perform a
quantitative analysis of their tax risks.
e) Financial Forecasts
The forecasts involved in financial due diligence include: incomes, investment scales,
capital requirement,changes in major accounting policies, etc. All these are finally
reflected in the forecast of cash flows and earnings capacity. Certified public accountants
must carry out appraisals of the industry outlook, policy orientation, interest rates,
exchange rates, changes in taxation, etc. In addition, when dealing with primary facts
involved in the forecasts, one must maintain a professionally sceptical attitude and verify
them with utmost prudence.
(2) Contents of Investigative Work
a) Investigation of the overall financial data of the target company
In financial due diligence, some basic financial circumstances of the target company need
to be understood. One can learn its time of establishment, history, registered capital,
shareholders, modes of investing capital, properties and major businesses, etc. through
obtaining the company’s business licence, capital verification report, constitution and
organisational structure. A detailed understanding of the target company should also
contain the head office and all the companies under its control, including the proper
information of its related parties. Moreover, the target company’s tax policies should be
covered, which comprise current tax types, tax rates, bases for calculation, the collecting
departments, preferential tax policy, tax allowance and
exemption, and settlement and payment of annual enterprise income tax.
b) Investigation of the Target Company’s Specific Financial Condition
The reliability of the financial statements of the target company, which is related to its
own procedures of internal control, would affect that of financial due diligence.
Consequently, when conducting financial due diligence, the internal control of the
enterprise should be taken into account. After having developed an understanding of the
system of the internal control of the company, one can probe into its financial position
and profitability.
c) Investigation of Special Matters
Special matters refer to financial commitments, contingent liabilities, post balance sheet
events, related party transactions, off-book assets and liabilities, etc. which exist in the
target company. These items should be given high attention. More detailed primary
source documents are needed in order to assess their legitimacy and fully disclose them in
the financial due diligence report according to their materiality.
4. Completion Stage
The main contents of this stage are the preparation of work papers and drafting of the
report.
Due to the particularity of the project and the uncertainty of information collection, it is
not probable that the work papers of financial due diligence can be of the standards of
financial statement audit. It is more likely to depend on the personal ability and the
professional judgement of the executive staff. In terms of the preparation of the work
papers, evidence for professional judgement is communicated in greater detail. (Is more
emphasised).
In the financial due diligence report, findings should be stressed. The wording of the
conclusion should be prudent and suggestive. Under the circumstances of inadequate
basis, excessively positive conclusions should be minimised. The incompleteness of
obtained information and work scope needs special emphasis. The disclaimer and the
usage of the report should be expressed in an explicit way. When narrating the
conclusion, firstly, one could make a general evaluation of the investment project, which
is primarily a summary of the investment value of the company. Secondly, an overall
estimation of the level of risk involved in the project should be given. Lastly, measures to
avoid risk and suggestions regarding the steps of acquisition should be put forward to the
acquiring party.

COMMON ISSUES SEEN IN FINANCIAL DUE

DILIGENCE.
1. Application of Accounting Standards
During due diligence investigations, it is frequently revealed that the target company fails
to some extent, and for various reasons, to comply with accounting standards. A typical
and recurring example being that the target company recognises income on cash basis in
place of accrual basis with a view to underpaying or avoiding
There can also be differences resulting from a need to use the accounting standards
adopted by the acquirer other than that of Chinese accounting standards, for example
United States accounting standards. An example is that China’s companies are not
allowed to calculate income tax after offsetting profits and losses among different units
under the same corporate group, but the US allows income tax to be paid on the level of
corporate group after the compensation of profits and losses.
2. Contingent Liabilities
During the course of the due diligence process, target companies are often found to have
contingent or improperly recorded liabilities. Examples of such are guarantees or
assurances provided by a third party or an affiliated company, unused annual leave of
employees, insufficient or non-payment of employee social insurance and taxes, and
possible litigation risks caused by violation of the laws and regulations relating to the
businesses of the target company.
3. Related Party Transactions
During the due diligence process, problems regarding related party transactions are often
found. For instance, the terms of trade are not compatible with the principle of
independence; the target company provides off balance sheet guarantees for the
transactions or liabilities of its affiliated companies for the overall interests of the
corporate body instead of business objectives.
4. Mortgaged or Defective Assets
Particular attention should be paid to the fact that assets of the target company may well
have been mortgaged or used as guarantees for other liabilities, or its factory or office
premises might not have valid planning or construction permits, or some premises might
not provide certification of ownership for their operating and available properties, all of
which could severely distort records of income and expenditure.
5. Income Tax Payments
Through understatement of turnover or overstatement of operating expenditure, the target
company might (willfully or inadvertently) underpay or not paying corporate and
individual income taxes.

FOLLOW UP WORK AFTER FINANCIAL DUE

DILIGENCE.
1. Specialist Assistance for Investment Program
- Proposed resolutions for corporate financial risk (discovered in the course of financial
investigation);
- Financial feasibility of investment model
- Financial forecast of investment returns;
- Financial risk evaluation of investment program.
2. Integration Program and Specialist Assistance
- Evaluation of the professional competency of the target firm’s financial personnel and
internal audit personnel;
- Recommending financial and internal audit personnel
- Assistance for financial management system and internal control system perfection or
establishment;
3. Pre-transaction Asset Valuation Review
- Cooperate with assets valuation work;
- Connecting with valuation firms, ensuring favourable asset evaluation results;
- Constructive suggestion regarding important issues of asset valuation
4. Post-transaction Financial Audit and Internal Audit

IMPORTANCE OF FINANCIAL DUE DILIGENCE FOR

TARGET FIRMS.
From the perspective of the selling side, the importance of financial due diligence is
embodied in the following
aspects;
1. Effectively Preparing for Impending Merger and Acquisition Negotiations
Financial report forms act as a mirror, what presents itself in this mirror is the overall
capacity of the enterprise.Through financial due diligence the selling firm can take a step
towards understanding its own key strengths and shortcomings. This lets the selling party
whilst conducting negotiations with the acquiring party to have greater confidence, to be
able to understand and play to its strengths. Even if confronted with unavoidable
questions, because sufficient preparation has been carried out in advance, the selling side
is more than capable of putting forward the appropriate responses.
2. Raising the Firms Value
A single good financial due diligence report can make known a firms various issues, for
instance questions of operation and internal control. Constructive suggestions from
relevant financial specialists can still assist the firm in further perfecting or correcting
issues that are discovered. This contributes to the firms raising operational efficiency, and
ultimately the value of the firm itself.

UNDERSTANDING THE DIFFRENCE BETWEEN

FINANCIAL DUE DILIGENCE AND AN AUDIT.
In the context of mergers and acquisitions, potential investors often feel a level of
comfort when their investment target is audited. However, relying solely on a target’s
audited financial statements when making an investment decision may be shortsighted.
An audit’s purpose is to provide assurance that management has presented a true and fair
view of a company’s financial performance and position , but audited financials often do
not identify significant issues likely to be of interest to a buyer or seller.
The due diligence process typically covers a wide range of areas, including legal,
information technology, operational, marketing and financial matters. Financial due
diligence (often referred to as “accounting” due diligence) focuses on providing potential
investors with an understanding of a company’s
(i) sustainable economic earnings.
(ii) historical sales and operating expense trends.
(iii) historical working capital needs.
(iv) key assumptions used in management’s forecast.
(v) key personnel and accounting information systems.
Although audits may provide a starting point for a potential investor’s evaluation of a
company, they generally do not comment on the focus areas noted above.
As an analogy demonstrating the difference between an audit and financial due diligence,
imagine a close friend entrusts you to buy him a used car. Having searched the
classifieds, you find what appears to be the perfect car, and the seller provides you with a
certificate from a reputable mechanic. The purpose of the certificate is to provide a
certain degree of comfort that the car is roadworthy.
Although the certificate verifying the car’s roadworthiness is nice, you may insist on
performing your own “due diligence”. Personally inspecting the car, kicking the tires,
and taking a test drive might make you more comfortable about your friend’s potential
purchase. In fact, you may even want to hire another mechanic that you know and trust
to perform a more thorough inspection. Your mechanic knows more about your specific
concerns and can delve deeper into the car’s history, operational features, and
maintenance record to help you decide if it’s a lemon.
The financial due diligence provider is that second mechanic. Based on the investor’s
specific concerns, the financial due diligence provider can alter the scope of the
engagement to address specific key risks. The diligence provider can “kick the tires” and
delve deeper into deal breaker issues and other potential areas of concern.

Quality of earnings
For obvious reasons, investors are particularly concerned with the fair valuation of the
business. Because businesses are often valued based on a multiple of EBITDA (earnings
before interest, taxes, depreciation and amortization),[5] financial due diligence providers
focus on the “quality,” or sustainability, of the company’s earnings. Unusual or non-
recurring income and expense items, over/understated assets and liabilities, post-closing
cost structure changes, and the inconsistent application of accounting principles are all
analyzed to adjust historical EBITDA to reflect sustainable earnings. The sustainability
of a company’s EBITDA is not reflected in a standard audit report.

Trend analysis
Audit procedures may include analytics to understand trends and relationships over the
historical period, but audit reports do not comment on the market drivers behind those
trends. Financial due diligence reports address key market drivers, sales strategies,
customer relationships and customer churn, and attempt to understand whether the trends
reflected in the financials are sustainable. Financial due diligence providers may also
analyze the target’s cost structure and vendor relationships to identify potential post-
transaction synergies.

Working capital
Buyers and sellers typically negotiate a “target” working capital to be delivered at
transaction close. The negotiated amount is usually based on the average working capital
balances over the previous twelve months, but a sophisticated buyer may also consider
(i) recent growth trends
(ii) industry conditions
(iii) the seasonality of the business
(iv) the specific composition of working capital balances.
An audit report does not provide insight into monthly working capital accounts, putting
the buyer at a significant disadvantage when negotiating the working capital target.

Forecast
Audits are concerned with historical financial statements only. Investors, however, are
more interested in the company’s ability to sustain and grow earnings. For that reason,
investors need to understand the key assumptions used by the company’s management
team in assembling the forecast. Financial due diligence providers often analyze the
company’s forecast and document the key assumptions to enable the investor to assess
the feasibility of that forecast.

Qualitative observations
Perhaps most importantly, the financial due diligence provider may provide the investor
with key qualitative observations from discussions with management. These
observations may include key findings regarding the Company’s internal control
structure, management and accounting team, and accounting information systems.
Qualitative observations rarely appear in audited financial statements, but may be just as
important in helping a buyer make an investment decision.
Summary
An audit provides assurance that management has presented a true and fair view of a
company’s financial performance and position in accordance with well-defined rules and
procedures. For a buyer to make a well-informed investment decision, however, he/she
should understand that an audit is a complement to, rather than a substitute for, a
specifically tailored financial due diligence investigation of the investment target.
Summary of key differences between audits and financial due diligence engagements:

FDD REPORT.
FINANCIAL DUE DILIGENCE REPORT (FDD):-
Financial due diligence is a reasonable level of enquiry into the financial affairs having a
material impact on the prospects of the business.
A FDD reveiws may not only look at the historical financial performance of a business
but will generally consider the forecst performance also.
FDD is about evaluation, interpretation, and communication.

OBJECTIVES OF FDD REPORT:-

1. Itentify the potential risks for the buyer in its investment decision
2.Evaluate quality of reported earnings and identify value delivers critical to the
transaction.
3.Corrobrate buyer assertions regarding target's financial positions.
4.Identify issues to be addressed in purchase agreement.
5.Identify areas for post-acquisition attention.
6.Improve transactions structure.
7.Assess strengths of financial personnel and systems.

FRAMEWORK OF FDD REPORT:-

1.Environment
2.Owners / Alliances
3.Values
4.Customers
5.Management
6.Competitors
7.Business process
8.Suppliers

PROCESS OF FDD REPORT:-

1.Define scope and information required.
2.Analysis of preliminary information.
3.Industry research.
4.Understand key transaction drivers.
5.Analysis historic financial statement.
6.Discussion with key people to validate findings.
7.Discuss the implication of key findings with the management.
8.Issues the final report.

DUE DILIGENCE IN OTHER AREAS.

Due Diligence for Purchasing Commercial Property

Environmental Concerns - Does the property contain hazardous materials like asbestos,
lead paint, or radon? If it does, have assessments done on the costs to mitigate the hazard.
Does the property sit on a flood zone, active fault-line, or protected environment?
Location - What are the mineral, gas, and oil rights to the property? How much traffic
will pass by your business each day? Is it easy to enter and exit? Is there enough parking?
Building inspection - A qualified building inspector will perform the inspection for you
but, in the meantime, are there any liens on the property? Were all contractors who
worked on the property paid by the previous owner?
Code Compliance - Does the property comply with all building safety, and zoning
codes?
Performance Data - How did the current owner perform in this space? (obtain business
information like profit/loss statements if possible)

Due Diligence for Adding a Vendor

·91 Is the ordering process easy and straightforward?
·92 Do they have multiple warehouses in case a product is out of stock at one site?
·93 Is a warehouse close enough that shipping costs will be minimal?
·94 From the time of the order, how long until it arrives at your door?
·95 How often do they bill and what are the terms?
·96 If the company is manufacturing products for you, are they large enough that you
can feel confident that any money paid upfront is safe?
·97 Are they willing to put special pricing in writing?
Due Diligence for Hiring an Employee
·98 Ask for three references and personally verify at least two.
·99 For professional positions, verify that the person has the credentials they listed on
their resume. Ask for copies of degrees, certifications, and experience. When
checking references, verify that they worked in the capacity listed on their
resume.
·100 Test their skills to assure they have core knowledge. Make a test on your
own or check with your industry trade group about ready-made assessments.
·101 Psychological testing is important for high stress positions. (More
information here.)
 ·102 Perform a background check.
·103 With the candidate’s permission, perform a credit check if the position
involves access to financial accounts or other related position.
·104 Conduct an interview and ask another trusted person to conduct another.
The Hard Truth
Due diligence is time consuming, inconvenient, tedious, and sometimes expensive. It
goes beyond the basic checks you would normally make and it’s safe to say that if you
didn’t find it to be about as fun as going to the dentist, you probably didn’t do it right.
You should know just as much about the business or person as you do about your own
business.

FINDINGS OF DUE DILIGENCE.

During the due diligence stage of an M&A deal, a buyer conducts a detailed final review
of a business to make sure they've uncovered any issues that may reduce the value of the
company. Most of the time, business owners make accurate financial and legal
representations to potential buyers when selling their companies. However, buyers
sometimes uncover serious and previously undisclosed issues that threaten the value of
their deal.
The following examples are just a handful of the red flags a buyer may encounter during
the due diligence stage of buying a business.
Losing a large customer
Some businesses have a single customer that is responsible for a large percentage of the
company's sales. In such cases, a member of the buyer's deal team may wish to interview
the target's main customer to assess the vendor/customer relationship and determine the
likelihood of maintaining the client after a change in ownership.
Consider this scenario: a buyer is seriously evaluating the purchase of a business that has
a client who represents nearly one-fourth of its revenue. During the due diligence
process, a representative from the buyer's party discovers that the customer plans to
withdraw its business due to a change in strategic direction. In fact, the client had
informed the company of the change four months earlier. The seller hadn't disclosed this
development, knowing it would have an adverse effect on the company's future
profitability.
To protect themselves from similar issues, buyers will typically add a material adverse
change clause to their purchase agreement. Such clauses cover events that occur between
the signing of a letter of intent and closing. In situations similar to the one described
above, a buyer would likely want to back out of a deal and could exercise the clause,
citing dishonest behavior on the part of the seller.
Void on management team
Many buyers search for acquisitions with experienced management teams that can
continue growing the business after a deal closes. In the due diligence process, some
buyers may discover that a company's leadership team isn't prepared to manage the
business in the previous owner's absence.
Before marketing their company for sale, a business owner may realize that there is a
void in the company's top management structure. Knowing that buyers would likely be
deterred from a company without management infrastructure, an owner may accidentally
hire the wrong person to fill the void. A company with a weak management team may
represent too much risk for a potential buyer.
Troubling legal past
Occasionally, a deeper look into a company's past will reveal evidence of pending
lawsuits or a history of legal battles fought against a customer, former employee,
regulatory agency, shareholder, or supplier. A key manager at the company, or even the
owner, could have a hidden criminal past or have faced allegations of fraudulent behavior
before joining the business.
Such findings can make a buyer question the integrity of the company and its leadership.
In some transactions, an owner may plan to stay on and run the company after it is sold.
However, if too many questions arise during the litigation analysis of the business, a
buyer may perceive the owner's presence as too risky and could end talks.
If buyers notice some indication of fraudulent behavior, they could become worried about
the integrity or accuracy of the company's financial statements and choose to hire a
forensic accountant to review them. If they can verify that the seller's financial records
are clean, they may choose to move forward with a deal and negotiate provisions to end
the owner's association with the company once it is sold.
Labor law violations
M&A due diligence teams will spend substantial time exploring the various components
related to acquiring or combining workforces. This includes reviewing the seller's
employee benefit plans, as well as ensuring their current and past personnel policies are
in compliance with federal and state labor laws.
Sometimes, a buyer will discover potential liabilities that are a result of employee rights
violations by the seller. Certain violations can result in severe penalties that can amount
to several millions of dollars. A buyer would undoubtedly want to protect themselves
from assuming such a liability, especially if it came as a result of the previous owner's
negligence.
Uncovering a pending liability with a stiff penalty can easily derail a transaction,
especially one involving a smaller company. If a buyer suspects future complaints may be
filed against the company, yet they still wish to purchase the business, they may try to
negotiate indemnification provisions that would protect them from being held liable for
damages in such claims.
End of the deal?
As the examples above illustrate, due diligence can uncover a wide variety of potentially
damaging issues. It's important for buyers to work with their financial and legal advisors
to assess each due diligence concern and evaluate how it impacts their deal's value.
Ultimately, a buyer will need to determine whether the issue is either surmountable or
significant enough to end the transaction.

CONCLUSION.

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 sounds impressive but ultimately it translates
into basic commonsense success factors such as "thinking things through" and "doing
your homework".
There are many reasons for conducting due diligence, including the following:
·105 Confirmation that the business is what it appears to be;
·106 Identify potential "deal killer" defects in the target and avoid a bad
business transaction;
·107 Gain information that will be useful for valuing assets, defining
representations and warranties, and/or negotiating price concessions; and
·108 Verification that the transaction complies with investment or acquisition
criteria.
Lead and co-investors, corporate development staff, attorneys, accountants, investment
bankers, loan officers and other professionals involved in a transaction may have a need
or an obligation to conduct independent due diligence. Target management typically
assists these parties in obtaining due diligence information but because it is unwise to
totally rely on management third party consultants such as Astute Diligence are often
brought in to conduct due diligence.
Initial data collection and evaluation commences when a business opportunity first arises
and continues throughout the talks. Thorough detailed due diligence is typically
conducted after the parties involved in a proposed transaction have agreed in principle
that a deal should be pursued and after a preliminary understanding has been reached, but
prior to the signing of a binding contract.
The parties conducting due diligence generally create a checklist of needed information.
Management of the target company prepares some of the information. Financial
statements, business plans and other documents are reviewed. In addition, interviews and
site visits are conducted. Finally, thorough research is conducted with external sources --
including customers, suppliers, industry experts, trade organizations, market research
firms, and others.
The amount of due diligence you conduct is based on many factors, including prior
experiences, the size of the transaction, the likelihood of closing a transaction, tolerance
for risk, time constraints, cost factors, and resource availability. It is impossible to learn
everything about a business but it is important to learn enough such that you lower your
risks to the appropriate level and make good, informed business decisions.
Due diligence costs are based on the scope and duration of the effort, which in turn are
dependent on the complexity of the target business and other factors. Costs are typically
viewed as an essential expense far outweighed by the anticipated benefits and the
downside risks of failing to conduct adequate due diligence. The involved parties
determine who will bear due diligence expense.
Every transaction will have different due diligence priorities. For example, if the main
reason you are acquiring a company is to get access to a new product they are developing
to accelerate your own time to market, then the highest priority task is to ensure that the
product is near completion, that there are no major obstacles to completion, and that the
end product will meet your business objectives. In another transaction, the highest
priority might be to ensure that a major lawsuit is going to be resolved to your
satisfaction.
Certain activities conducted during due diligence can breach confidentiality that a
transaction is being contemplated. For example, contacting a customer to assess their
satisfaction with the target company's products might result in a rumor spreading that the
company is up for sale. Accordingly, to maintain confidentiality, we often contact
customers under the guise of being a prospective customer, journalist, or industry analyst.
A well-run due diligence program cannot guarantee that a business transaction will be
successful. It can only improve the odds. Risk cannot be totally eliminated through due
diligence and success can never be guaranteed.

REFERENCE.
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WWW.TECHTARGET.COM
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