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DUE DILIGENCE CA. Rajkumar S Adukia B. Com(Hons. ) FCA, ACS, MBA, AICWA, LLB DUE DILIGENCE CA. Rajkumar S Adukia B. Com(Hons. ) FCA, ACS, MBA, AICWA, LLB , Dip In IFRS(UK) [email protected] com www. carajkumarradukia. com 9820061049/9323061049 o To receive regular updates kindly send test email to [email protected] com o

DUE DILIGENCE DUE DILIGENCE

CONCEPT @ @ It’s a proactive management tool. Taking every reasonable precaution. It is CONCEPT @ @ It’s a proactive management tool. Taking every reasonable precaution. It is essentially an investigation to manage risks. Systematic, structured research effort to ascertain and accumulate facts necessary to make an informed investment “decision”. @ In common parlance, a care that a reasonable person or organization exercises under specific circumstances to avoid harm to themselves or others.

DEFINITION AND MEANING OF DUE DILIGENCE @ A measure of prudence, activity, or assiduity, DEFINITION AND MEANING OF DUE DILIGENCE @ A measure of prudence, activity, or assiduity, as is properly expected from, and ordinarily exercised by, a reasonable and prudent man under the particular circumstances. ” @ Black’s Law Dictionary with Pronunciations, sixth edition 1994, p. 457 @ Due Diligence is a process of investigation undertaken by various lenders including banks and financial institutions for assessing the performance of business. @ The process of investigation performed by investors into the details of a potential investment such as examination of operations and management and the verification of material facts.

HISTORICAL BACKGROUND OF DUE DILIGENCE @ The term Due Diligence was first used under HISTORICAL BACKGROUND OF DUE DILIGENCE @ The term Due Diligence was first used under US Securities Act, 1933 as Due Diligence Defence. @ Due diligence defense is generally used by brokersdealers for inadequate disclosure to investors. @ Initially, Due Diligence was restricted to Initial Public Offer (IPO) only but overtime Mergers and Acquisitions etc. also found the place. @ Due Diligence helps to get the realistic picture of business today and tomorrow.

OBJECTIVES OF DUE DILIGENCE @ To spot out the evils, which may invite some OBJECTIVES OF DUE DILIGENCE @ To spot out the evils, which may invite some unanticipated liabilities in future. @ To forecast the future performance of an organization by analyzing the potential risks and threats. @ To help in identifying liabilities, negotiate a lower price, avoid lawsuits and costly mistakes and top of all to make good business and financial decisions.

WHY DO YOU CONDUCT A DUE DILIGENCE? @ Essential to determine the hidden risks WHY DO YOU CONDUCT A DUE DILIGENCE? @ Essential to determine the hidden risks which are attached to the transaction as it may result in the transaction being aborted or affect the purchase price or terms of the agreement. @ Transactions involve substantial financial obligations. @ The need for Due diligence is sought to unearth the secrets which every business tend to have one. @ Good Corporate Governance DUE DILIGENCE

WHY - DUE DILIGENCE? Investment Risk Assessment Negotiation Valuation üValidate assumptions of Information Memorandum WHY - DUE DILIGENCE? Investment Risk Assessment Negotiation Valuation üValidate assumptions of Information Memorandum üUnderstanding Investment Return & Risk üProfitability /Performance Ratios üROCE vis-à-vis Cost of Capital üCash Flow analysis üIdentify üPotential Adjustments üPotential Risk/Exposures üOff balance sheet exposures

WHY - DUE DILIGENCE? üIdentify Information not presented Shock Absorber üLegal Non-Compliances üIncorrect Representations/Information WHY - DUE DILIGENCE? üIdentify Information not presented Shock Absorber üLegal Non-Compliances üIncorrect Representations/Information Memorandum üReduce Surprise from becoming Black holes üRed Flags üIdentify exclusions to be mentioned in Deal Structuring/ Agreement Final Agreement üExclusions – Ownership encumbrances üShareholders Agreement üContingent liability üIndemnity/Warranties ü Identify structuring issues – e. g. Lease & buy back ü

WHY - DUE DILIGENCE? Enhance Understanding üIdentify Growth Drivers and USP üAnalyze Present Key WHY - DUE DILIGENCE? Enhance Understanding üIdentify Growth Drivers and USP üAnalyze Present Key Business Drivers üReview bottlenecks üStrategy for future üSystems & Personnel - information

DUE DILIGENCE vis-à-vis AUDIT @ Due Diligence is far beyond the financial analysis. Audit DUE DILIGENCE vis-à-vis AUDIT @ Due Diligence is far beyond the financial analysis. Audit is concerned with the truth and fairness of historical financial statements only. @ Due Diligence can be conducted by any of the professionals whereas Audit is to be conducted mandatorily by the Chartered Accountants.

STATUTORY AUDIT & DUE DILIGENCE REPORT (DDR) –A COMPARISON Statutory Audit DDR Scope Defined STATUTORY AUDIT & DUE DILIGENCE REPORT (DDR) –A COMPARISON Statutory Audit DDR Scope Defined Tailor Made Legal Requirement Mandatory Non-Mandatory Historical focus Historical and futuristic focus Focus

STATUTORY AUDIT & DUE DILIGENCE REPORT (DDR) –A COMPARISON Statutory Audit DDR Appointment Appointed STATUTORY AUDIT & DUE DILIGENCE REPORT (DDR) –A COMPARISON Statutory Audit DDR Appointment Appointed by the company Appointed by either the buyer or the seller Attitude Watch-Dog Investigator Emphasis True & Fair üCommercial Aspects üIssues concerning Term sheet

TRADITIONAL V/S VIRTUAL DATA ROOM @ Traditional Due Diligence Data Room – Data is TRADITIONAL V/S VIRTUAL DATA ROOM @ Traditional Due Diligence Data Room – Data is available in a lawyer’s office or conference room @ Virtual Due Diligence Data Room – Data is accessed through the internet.

TRADITIONAL V/S VIRTUAL DATA ROOM @ Location - A traditional data room is usually TRADITIONAL V/S VIRTUAL DATA ROOM @ Location - A traditional data room is usually located at a nearby lawyer’s office to increase security. This also increases costs. A Virtual data room is located on a secure server at a third party data center. @ Effort - Traditional data room will require the printing and indexing of many electronic documents, financial spreadsheets and contracts. While many paper documents must be scanned to create the electronic images for a virtual data room all of the electronic documents can be processed online. @ Security - With a lawyer’s office the security is only as good as the paralegal who is in the room taking care of the documents. If implemented correctly a virtual data room can be more secure than a lawyer’s office. You can restrict who sees what documents and who can copy what documents.

TRADITIONAL V/S VIRTUAL DATA ROOM @ Cost - A Traditional data room is not TRADITIONAL V/S VIRTUAL DATA ROOM @ Cost - A Traditional data room is not as cheap as the Virtual data room after you add up the labor to copy and index all the documents plus the legal office space to manage a multi week data room effort. @ Record Activity – In a Traditional data room you cannot record who sees what document, wherein in a Virtual data room, however, one can have daily reports of who viewed at which documents. @ Document Reviewers – In a Virtual data room one can keep track of who reviewed which documents, on the other hand such an advantage is lacked in a traditional data room. @ Lower Investor Risk – There is less investor risk involved in the case of a Virtual data room as compared to a Traditional data room.

TRADITIONAL V/S VIRTUAL DATA ROOM @ Multiple Bidders - A Virtual data room by TRADITIONAL V/S VIRTUAL DATA ROOM @ Multiple Bidders - A Virtual data room by its nature can allow all users to access the same documents concurrently and in private. @ New Info Distribution - Bidders will often submit questions and request additional data. With a Virtual data room is very easy to add new documents to the data room and notify everyone of its posting. @ Restrict Access – In a Virtual data room the access to the information may be restricted to specific / authorised people.

VARIOUS TYPES OF DUE DILIGENCE TYPES BUSINESS FINANCIAL LEGAL SECRETARIAL VARIOUS TYPES OF DUE DILIGENCE TYPES BUSINESS FINANCIAL LEGAL SECRETARIAL

BUSINESS DUE DILIGENCE & Business Due Diligence aims to ensure that the buyer gets BUSINESS DUE DILIGENCE & Business Due Diligence aims to ensure that the buyer gets all the material facts required to make a fully informed decision and assessment of the true condition of the business while not disrupting the seller’s business unduly. & Timing is critical. It is best to work out some type of planned schedule in advance so everyone’s expectations are met and we do not have disagreements or unnecessary delays. & It includes: & Operational due diligence & Strategic due diligence & Technical due diligence & Environmental due diligence & Human Resource due diligence

FINANCIAL DUE DILIGENCE & Financial due diligence analyzes, qualitatively and quantitatively, how an organization FINANCIAL DUE DILIGENCE & Financial due diligence analyzes, qualitatively and quantitatively, how an organization has performed financially to get a sense of earnings on a normalized basis. & It includes: & & & & Review of accounting policies Review of internal audit procedures The quality and sustainability of earnings and cash flow The condition and value of assets, liabilities and potential liabilities Accounting systems and controls Tax implications of deal structures Examination of key operational processes Examination of information systems to establish the reliability of financial information

LEGAL DUE DILIGENCE & Legal Due Diligence is about the management of risk. & LEGAL DUE DILIGENCE & Legal Due Diligence is about the management of risk. & The Legal Due Diligence covers two aspects – intracorporate transactions and inter-corporate transactions. & Legal Due Diligence investigations give the most complete picture of a company.

LEGAL DUE DILIGENCE & The investigation or inspection would cover: & Compliance with local LEGAL DUE DILIGENCE & The investigation or inspection would cover: & Compliance with local laws & Securities or other regulatory violations or disciplinary actions & Extensive litigation and/or bankruptcies – assessment of feasibility of pursuing litigation & Financial statements & Unpaid tax liens and/or judgments & Past business failures and related debt & Fraudulent or exaggerated credentials & Misrepresentations or character issues & Discoveries and disclosures & Assets – real and intellectual property, brand value & Reputation and goodwill & Cross-border issues – double taxation, foreign exchange fluctuation, sovereign risk, investment climate, cultural impact on human resources.

SECRETARIAL DUE DILIGENCE & Secretarial Due Diligence ensures that the targeted company has duly SECRETARIAL DUE DILIGENCE & Secretarial Due Diligence ensures that the targeted company has duly complied with the corporate laws and regulations and other applicable provisions, if any. & It refers to the secretarial audit of the company.

SELECTION OF A DUE DILIGENCE CONSULTANT @ Clarity of object @ Size of the SELECTION OF A DUE DILIGENCE CONSULTANT @ Clarity of object @ Size of the organisation @ Key Concept to be kept in Mind @ @ @ Avoid "Casual" Due Diligence Consultants Consider an End-to-End Provider Beware of Hidden Interest Multi -Functional Expertise Secure Long-Term Relationships with Your Consultant @ Selecting the Best Firm DUE DILIGENCE

SELECTION OF A DUE DILIGENCE CONSULTANT @ Client base of the Consulting Agency @ SELECTION OF A DUE DILIGENCE CONSULTANT @ Client base of the Consulting Agency @ Meetings should be arranged @ Terms & Conditions should be discussed before hand @ Consultant should be selected vigilantly

CRUCIAL FACTORS TO BE CONSIDERED WHILE CONDUCTING DUE DILIGENCE @ Be prepared with : CRUCIAL FACTORS TO BE CONSIDERED WHILE CONDUCTING DUE DILIGENCE @ Be prepared with : @ A detailed listing of the exact due diligence steps to follow @ A checklist of everything to complete in each due diligence area @ Specific due diligence tasks that need to be completed @ All of the materials you need from the seller before you start

CRUCIAL FACTORS TO BE CONSIDERED WHILE CONDUCTING DUE DILIGENCE @ Allow yourself time @ CRUCIAL FACTORS TO BE CONSIDERED WHILE CONDUCTING DUE DILIGENCE @ Allow yourself time @ Information from vendors and customers @ Analyse financial as well as following key factors: @ @ @ The management team’s past performance, roles and talent Organizational strategy and business plans Risk management structure Technological superiority Adequacy of infrastructure @ Internet Research

PROCESS OF CONDUCTING DUE DILIGENCE Planning Preparation of Due Diligence Report Data Collation Data PROCESS OF CONDUCTING DUE DILIGENCE Planning Preparation of Due Diligence Report Data Collation Data Analysis

PLANNING @ @ Scope and Core areas Appointment of the team - Skills/expertise Clear PLANNING @ @ Scope and Core areas Appointment of the team - Skills/expertise Clear and definite mandate Defining the time schedules- how to deal with challenges within agreed time frame with available resources @ Timely communication of information requirements (Due Diligence Checklist) 29

DATA COLLATION @ Research for data could be either qualitative or quantitative @ One DATA COLLATION @ Research for data could be either qualitative or quantitative @ One on one interviews with management from the target company @ Data room and access to the room @ Sources : Internet, Competitors, Industry associations, Regulatory organizations and databases which will include searches of public registers, Customers, Vendors etc.

DATA ANALYSIS @ Understanding everything you can about the company @ It should be DATA ANALYSIS @ Understanding everything you can about the company @ It should be done keeping in mind the objectives of Due Diligence @ The analysis of due diligence findings is generally a weighing of a variety of factors in order to determine whether team should give a positive recommendation eg : business criticality, functional complexity, technical complexity, infrastructure requirements etc. DUE DILIGENCE

PREPARATION OF DUE DILIGENCE REPORT @ A summary of the scope of the review PREPARATION OF DUE DILIGENCE REPORT @ A summary of the scope of the review @ A list of all the information disclosed by investigations @ An analysis of the documentation and information revealed @ An executive summary which outlines the legal issues identified and advises on the legal implications of proceeding with the transaction (Risks and Liabilities) @ Highlight the material issues arising from the due diligence review and advice on the factors influencing the price to be paid

ROLE OF PROFESSIONALS INVOLVED IN DUE DILIGENCE Professionals involved in Due Diligence $ Company ROLE OF PROFESSIONALS INVOLVED IN DUE DILIGENCE Professionals involved in Due Diligence $ Company Secretaries $ Chartered Accountants $ Cost Accountants $ Advocates / Solicitors $ Financial Analysts Professionals should have $ Expert knowledge $ Analytical & business advisory skills $ Clarity of object $ Confining to time frame and deadlines

AREAS REQUIRING DUE DILIGENCE [A] MERGER, AMALGAMATION AND ACQUISITION @ @ Due diligence is AREAS REQUIRING DUE DILIGENCE [A] MERGER, AMALGAMATION AND ACQUISITION @ @ Due diligence is a comprehensive undertaking in cases of potential mergers and amalgamation Track record of the past as well as future prospects of the company is required to know so as to identify the potential growth of the company. One should incorporate an element of objective self-analysis. To complete the Due Diligence within a reasonable period of time, - either @ @ @ outsource the Due Diligence task to a reputable research firm or build an efficient in-house program within their legal, marketing, or corporate security sectors. A detailed assessment of the market and target of the proposed acquisition should also be clear prior to closing a deal.

AREAS REQUIRING DUE DILIGENCE @ In today's fast-changing business environment, one should look into AREAS REQUIRING DUE DILIGENCE @ In today's fast-changing business environment, one should look into following areas: @ @ @ @ Financial Research and Development Intellectual Property Material Agreements Assets/Liens Employment-related matters Corporate Issues Licensing and Litigation DUE DILIGENCE

AREAS REQUIRING DUE DILIGENCE [B] PARTNERSHIP @ One should conduct negotiations and investigation into AREAS REQUIRING DUE DILIGENCE [B] PARTNERSHIP @ One should conduct negotiations and investigation into affairs of the entities before entering into partnership. @ Different types of partnerships where due diligence investigation is required to be done: @ Strategic Alliances, Strategic Partnerships @ Business Partners and Alliances, Partnering Agreements, @ Technology and Product Licensing, Joint Development Agreements, Technology Sharing and Cross Licensing Agreements @ Business Partners, Affiliates, Franchisees and Franchisers.

AREAS REQUIRING DUE DILIGENCE [C] INTELLECTUAL PROPERTY @ A detailed assessment of Intellectual Property AREAS REQUIRING DUE DILIGENCE [C] INTELLECTUAL PROPERTY @ A detailed assessment of Intellectual Property (IP) assets has become an increasingly integrated part. @ Due diligence process involves investigation of a party’s ownership, right to use and right to stop others from using the IP rights involved in sale or merger. @ Thorough internal assessment of its own assets can enhance IP planning and management. @ Acquiring or investing in a business that own IP assets require the scope and depth of due diligence.

AREAS REQUIRING DUE DILIGENCE CORE AREAS OF IP: (1) Significant patent issues – Scope AREAS REQUIRING DUE DILIGENCE CORE AREAS OF IP: (1) Significant patent issues – Scope of rights – Rights transferable –Issues raised by license agreements, other rights transfer agreements –Reviewing/evaluating all pending/threatened infringement claims/enforcement opportunities etc. (2) Significant copyright issues – Assignment and Registrations in Proper Order – Grants Effective – Rights Transferable

AREAS REQUIRING DUE DILIGENCE (3) Significant trademark issues – A list of all licenses, AREAS REQUIRING DUE DILIGENCE (3) Significant trademark issues – A list of all licenses, franchises, royalty agreements, or similar arrangements related to the target company and/or products – Third party use – Policing/licensing (4) Significant trade secret issues (5) Significant domain name issues

AREAS REQUIRING DUE DILIGENCE [D]INITIAL PUBLIC OFFER (IPO) @ Due Diligence plays a key AREAS REQUIRING DUE DILIGENCE [D]INITIAL PUBLIC OFFER (IPO) @ Due Diligence plays a key role in an IPO. @ Tool to optimize potential of the company, thereby increasing its value to potential investors. @ Due Diligence is required to be conducted by the Merchant Bankers.

AREAS REQUIRING DUE DILIGENCE @ Helps to identify any potential shortfalls in Corporate Governance AREAS REQUIRING DUE DILIGENCE @ Helps to identify any potential shortfalls in Corporate Governance issues or financial reporting procedures so that the company is able to take corrective action prior to listing. @ Pre-IPO Due Diligence process will result in a gap analysis between the present status of the company and the company that should be floated. @ It identifies the weaknesses and strengths of the company.

AREAS REQUIRING DUE DILIGENCE @ Provides comfort in preparing a prospectus in accordance with AREAS REQUIRING DUE DILIGENCE @ Provides comfort in preparing a prospectus in accordance with Securities Markets Act. @ Allows the management and lead manager to assess the reasonableness of the statements made in the prospectus as required by law. @ Helps the lead manager to understand the business of the corporation and the main risks associated with it.

CAUTIONS N Sensitivity by seller / issuer access of confidential data to investors, especially CAUTIONS N Sensitivity by seller / issuer access of confidential data to investors, especially when the latter are existing competitors. N Confidentiality Agreements : Limited disclosure to counter-party and its advisors with an obligation to return data in case deal falls through. DUE DILIGENCE

BOTTLENECKS @ Psychological Issues @ Information Overload @ Delay in reply to important queries BOTTLENECKS @ Psychological Issues @ Information Overload @ Delay in reply to important queries - “divert attention” @ Information provided in bulky format – Hard copies with unimportant details @ Practical Commercial Issues @ Financial & Accounting Scandals @ Non financial angle to weak areas DUE DILIGENCE

BOTTLENECKS @ Disapproval from the company. @ Outcome of the Due Diligence Process may BOTTLENECKS @ Disapproval from the company. @ Outcome of the Due Diligence Process may be consciously or unconsciously tainted by owners, managers and researchers who stand to benefit personally or professionally from the proposed activity. @ Due Diligence is a difficult and extensive experience. @ It is complex since more negatives may be established or envisaged. DUE DILIGENCE

CASE STUDY o A major US Company intended acquiring an independent BPO Company in CASE STUDY o A major US Company intended acquiring an independent BPO Company in India. The BPO Company as per their claims had an excellent line up of clients and credentials. They also claimed large business activity in Singapore. o The US Company wanted the due diligence team to find out if the acquisition candidate was indeed as sound as was made to believe, before they began any discussions with them. o The team’s investigations found that the BPO Company had started performing well only in the recent past, and that they were a group of companies and not one company, one of the companies of the group which had the same set of Promoters and Directors, had been sued against in the US for Product Liability. DUE DILIGENCE

DD is a “Mind-Game” between Seller and DD Team!!! DD is a “Mind-Game” between Seller and DD Team!!!

TIPS FOR EFFECTIVE DUE DILIGENCE @ Exhaustive list of requirements. @ Look for contradictory TIPS FOR EFFECTIVE DUE DILIGENCE @ Exhaustive list of requirements. @ Look for contradictory information or replies. @ Ask questions where the intentions / objectives are disguised so that the replier cannot manipulate the reply. @ Look at comments of Internal Audit Reports. @ In case of resistance in providing information try to figure out why the information is being withheld. @ Track the time period within which the replies are provided.

TIPS FOR EFFECTIVE DUE DILIGENCE @ Is the tone of reply defensive or attacking. TIPS FOR EFFECTIVE DUE DILIGENCE @ Is the tone of reply defensive or attacking. @ Look at transaction post Letter of Intent (LOI) and pre Due Diligence Report (DDR). @ Look for deferment or expedition of transactions. @ Review transactions with related parties and Transfer Pricing Policy for group company transactions. @ Scrutinize the legal and professional charges.

CONCLUSION F CONCLUSION F "Due Diligence" is simply a phrase used to describe what are generally, “business investigations”. It is commercial jargon for the detailed analysis and risk review of an impending commercial transaction. F Adequate Due Diligence helps the buyer to F ascertain the current business conditions F status on pending litigations F negotiation of purchase price F decide on the proposed investment

CONCLUSION FOREWARNED IS FOREARMED CAVEAT EMPTOR (LET THE BUYER BEWARE) CONCLUSION FOREWARNED IS FOREARMED CAVEAT EMPTOR (LET THE BUYER BEWARE)