Due Diligence is merely an investigative process where the potential buyer or purchaser ensures that the business or asset acquired does not have any form of flaws. The system of due diligence comes from a legal maxim called ‘Caveat Emptor’. This maxim means buyers beware. Hence the buyer has to take all reasonable steps to ensure that the business does not have any form of flaws.
The term due diligence is commonly used in Mergers and Acquisition (M & A) processes where there are different parties involved. Usually, due diligence services are carried out for a typical Merger and Acquisition process.
Due Diligence Services- What is it?
Due Diligence Services is a process in which an independent third-party consultant who is a lawyer, accountant, a financial firm or any other authority carries out the entire process of investigating into the potential purchase or transaction.
The consultant or party would have to liaise with different authorities, including the seller's side, government authorities, registrar of companies and land authorities. Through this process, previous information on the seller (seller’s side) would be received as a part of the transcation.
Hence the buyer must get due diligence services to assist in taking proper steps to go ahead with the purchase or to exit from the purchase.
Types of Due Diligence Services
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Financial Due Diligence
Financial Due Diligence is a process in which the buyer would investigate into the finance and accounting affairs of the company. Usually, financial practitioners and chartered accountants are hired to carry out this form of due diligence. By carrying out financial due diligence, the buyer would get a clear understanding of the financial and revenue position of the company. When carrying out the financial due diligence, it is essential to look into the financials of the company to determine the real and true position. For example, during a due diligence transaction, the company needs to look into the balance sheet, profit and loss account and other transactions which are carried out in the past.
Legal Due Diligence
This form of due diligence would investigate any form of legal issues faced by the seller or the asset in question. If the selling company or the asset being sold is under any form of litigation, then this would be looked into by the buyer. In a merger and acquisition process, usually, the buyer would pay more attention when it comes to legal due diligence. If there are any forms of compliance issues with the company, then this would be checked. Apart from this, if any subsidiary or firm of the seller has any form of debt, then, the concerned authority would be contacted. Hence, this form of due diligence is carried out to understand if there are any form of legal disputes faced by the seller. Usually, this due diligence would be carried out by transaction lawyers.
Environmental Due Diligence
This form of due diligence is carried out to understand if the company is complying with relevant environmental compliances. For example, this form of due diligence services would ensure that the company is complying with emissions and carbons levels. Any company which has an affluent or industrial unit would have to comply with the process. The buyer will have to investigate if the industrial unit has followed all the compliances.
Asset Due Diligence
In a Merger and Acquisition process, there are two parties- The buyer and the seller. Apart from them, other parties assist in carrying out a seamless process.
The M & A process can be divided into the following:
- Share Sale
Where a company (buyer) would acquire the entire share capital of the seller or a proportion of the share capital of the seller. Such a transaction is known as a share sale.
- Asset Sale
Usually when the buyer is purchasing some form of an asset of the seller, then this transaction would be called an asset sale. The asset in question can either be a movable property or an immovable property. It is important to understand that in an asset sale, only the asset is purchased by the buyer. Hence, due diligence services would relate to investigating only a particular asset in the transaction. For example, if the company is acquiring only some automobiles and heavy lifting equipment owned by the seller, then due diligence services would only be conducted on the automobiles and heavy lifting equipment.
Administrative Due Diligence
This form of due diligence services would involve investigating the administrative system in a company. The administration does not only include and involve the hierarchy of an organisation but also involves the working procedures of the company. This form of due diligence would look into different processes that are invoked by the company. However, administrative due diligence would not involve any form of strategic partnerships or agreements the seller’s company has entered into.
Management Due Diligence
Under this form of due diligence services would comprise of investigating the management of the organisation. The management of an organisation would comprise of executives who have the following positions:
- Chief Executive Officer
- Directors
- Shareholders
- Chief Financial Officer
- Chief Technology Officer
- Any other officer that has an executive position
Hence this form of due diligence services would investigate into the affairs of the management of the company. Criminal background checks would be conducted as a process of management due diligence. Apart from this, the process would also involve carrying out background checks into the management of the company.
Commercial Due Diligence
Under this form of due diligence services, commercial trends followed by the company will be considered. Here some form of the strategy formulated by the company would be looked into. The objectives and goals of the company would be analysed, and if there are any forms of deviations, then the same would be investigated. If the selling company or any of its subsidiaries has entered into any strategic partnerships or agreements, then the same would be investigated by the buyer. Usually, any form of third party consultants can carry out this form of due diligence services as it is looking into the long term and short term goals of the organisation. Through this form of due diligence, an organisation (buyer) can understand the strategic goals of the business (seller) and see if it matches the buyer’s present objectives.
Main Regulatory Authority for Due Diligence Services
As such, there is no central or primary regulatory authority for due diligence services. However, there are different authorities which the parties would have to liaise with.
The following are the authorities which the buyer would have to liaise within India:
- Companies Registry and Ministry of Corporate Affairs- For Company Law and other related matters.
- Competition Commission of India- For Competition and Anti-Trust Related Issues.
- Income Tax Authorities- For Taxation and Other Tax-Related queries.
- The Reserve Bank of India- For Banking and Payment Related Queries.
- State and Municipal Bodies- For Seeking Registration Clarifications and Any other requirements on the license.
Due Diligence Services Process
As mentioned earlier, the due diligence process would be more used in complex mergers and acquisitions.
However, the parties would have to consider the following process:
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Enter into Contracts after instructions
First and foremost both the parties would have to instruct their consultants for carrying out the process of due diligence services. Once instructions have been passed on, the buyer would receive advice regarding the process. After instructions are given, the parties would have to enter into respective agreements for the due diligence services. The contracts and agreements would comprise of the following:
- Heads of Terms of the Agreement- This would comprise of the main clauses of the acquisition agreement. The period and duration of the acquisition agreement would also be included under this.
- Confidentiality Agreement- The confidential agreement would include that, the parties to the contract should not breach any provisions under the agreement. If there is a breach, then the parties (buyer) or seller would have the provision for exiting the transaction. Apart from this the buyer or seller can sue for breaking the provisions of the contract.
- Lockout Agreements- These agreements would include that during the period of purchase, the seller does not have any rights to deal with any other buyers.
Due Diligence Questionnaire
The buyer would require to draft the due diligence questionnaire and forward the same to the seller. In this questionnaire, all questions have to be included regarding the company. The following questions would have to be included in the due diligence questionnaire:
- Any form of agreements that the company has entered into
- Contracts and Services Under Taking
- Any warranties or guarantees related to a particular asset under the company
- Any other IP Assets which is under the control of the company
- Any other form of questions which has to be addressed to the seller
- Supplier Contracts and Provisions
- List of Directors and Shareholders
- Remuneration and Service Packages of Employees
- Any form of Material Adverse Change in the Company
Respond to the Questionnaire
The seller has to take all the reasonable steps to respond to the questionnaire. All the responses by the seller have to be accurate and as per the requirements of the buyer. During this process, the seller must not cause any form of misrepresentation or breach of the agreement. If the queries asked by the buyer are unanswered, then the buyer may walk out of the transaction. However, the responses provided by the seller would be a decisive point if the buyer has to carry out the transaction or walk out of the transaction.
Draft the Acquisition Agreement
The next step in the due diligence services process is to draft the acquisition agreement. The buyer’s side lawyers would be part of drafting the acquisition agreement.
Negotiate Agreements
Once the acquisition agreement is drafted there will be negotiations carried out. Once this process is carried out, the buyer and seller would have to negotiate contracts, and if there are any forms of unreasonable clauses, the same has to be rectified.
Exchange Contracts
After negotiation phases, the contracts between the parties are exchanged for signing the contracts.
Complete the Transaction
Once this process is carried out, the whole procedure for due diligence services would be complete. With the end of the due diligence process, the acquisition can go ahead.
Enterslice Benefits- Due Diligence Services
- Enterslice is a recognized consultant in providing due diligence services.
- We have experienced professionals carrying out due diligence services.
- We have Multifaceted teams consisting of lawyers and transaction professionals.
- We have extensive experience in handling matters related to mergers, taxation, and accounting matters in India.
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Frequently Asked Questions
Due diligence is an investigation process in which one party finds out information about the other party. Due Diligence can be used in any form of process or business transaction.
Due diligence services are used in different fields. However, the following industries frequently use due diligence:
• Chartered Accountants
• Lawyers
• Financial Consultants
• Investment Banks
When banks use due diligence, the process is used for identifying potential customers. Such banks ask customers for information such as a passport or other Paper works in order to comply with relevant due diligence procedures. This form of due diligence is known as customer due diligence. The process of customer due diligence is used by banks and financial institutions to comply with the anti-money laundering procedures.
Data Room is also understood as a server room. As due diligence is a process where complex information is collected, such information is stored in a room known as a data room. Through this data room, information can be accessible during the due diligence process. A data room would only be utilised for complex mergers and acquisitions.
Both the above terms are used in contracts. An indemnity is something like a promise to indemnify another party in case of loss or any other defect. However, a warranty is something like a guarantee given by one party to another.
Yes, both the above are used in due diligence agreements. This will be the case if there is any form of breach of contract or misrepresentation given by either party.
The buyer would have the following remedies:
• Reduce the purchase price
• Renegotiate the terms
• Indemnification
• Walk out of the Transaction.
