Definition of Due Diligence
“Due diligence” is research and analysis of a business transaction. It is the research and methodological investigation of a business or organization, or the performance of an act with a certain standard of care to ensure that information derived during the due diligence is accurate and to uncover information that may affect the outcome of the transaction.
Due Diligence is the process of inquiries and investigations made by a prospective buyer in advance of the acquisition of a company to determine whether the acquisition should go ahead and upon what terms.
In fact, it is the basic investigation of the buyer to make sure that it knows what it is investing in and uncover possible threats which might be critical for the M&A success and know more about what it is buying.
Purpose of Due Diligence
The purpose of Due Diligence is to understand how Financial Due Diligence Save the prospective and a seller to reduce the M&A failure risks and what are its limits, and then to show how Strategic Due Diligence could be used to fulfill the Financial Due Diligence limits, and then be a better way to conduct Due Diligence process in order to increase the M&A chance of success.
Objective of Due Diligence
Due Diligence’s object is to ensure that the purchaser or acquirer does not get any unpleasant surprises after taking control of the business. Relying on the preceding financial audits of the target company and a conversation with its management is recognized as at best problematic or, worst, a patently disastrous route to familiarizing the buyer with the potential problem it is likely to face.
There are three principal reasons why Due Diligence disappoints or fail:
- The question was not asked in the first place: when the acquirer company management is overconfident about its knowledge of the target company.
- If the question were asked, satisfactory answers neither were nor obtained: the target company provide restricted answers, or claims to be bound by ‘commercial confidentiality’ or shelter behind a lack of effective record keeping, the risks soar.
- The deal process hampered the completion of effective DD: several deals constraints can happens as hostile acquisition, auction, time pressure, the sensitivity of the seller.
It is up to the team involved in the Due Diligence to analyze, identify and resolve potential key elements necessary to avoid the M&A fail.
Types of Due Diligence
Business Due Diligence : Business due diligence process varies for different types of companies. The relevant aspects which are very important may include the financial, legal, labour, tax, environment, and market/commercial situation of the company. Other areas which are material include intellectual property, real and personal property, insurance and liability coverage, debt instrument inspection, employee benefits and pending labour matters, immigration, and international transactions.
Legal Due Diligence : A legal due diligence extends to the legal aspects of a business transaction, liabilities of the target company, potential legal pitfalls, and other related issues.
Legal due diligence covers intra-corporate and inter-corporate transactions. It includes preparation of regulatory checklists meeting with management and personnel, independent check with regulatory authorities, inquiry with different departments etc. apart from document verification.
Financial Due Diligence : Financial due diligence provides peace of mind to both corporate and financial buyers, by analyzing and validating all the financial, commercial, operational and strategic assumptions being made.
Financial Due Diligence includes review of accounting policies, review of internal audit procedures, quality and sustainability of earnings and cash flow, condition and value of assets, potential liabilities, tax implications of deal structures, examination of information systems to establish the reliability of financial information, internal control systems etc.