Due Diligence

for
Mergers & Acquisitions

WHY DUE
DILIGENCE IS
IMPORTANT
BEFORE ANY
TRANSACTIONS

Why Due Diligence is Important for M&A.??

To investigate into the Affairs of Business as a prudent business person

To confirm all material facts related to the Business

To assess the Risks and Opportunities of a proposed transaction.

To reduce the Risk of post-transaction unpleasant surprises

To confirm that the business is what it appears.

Why Due Diligence is Important for M&A.Cont

To Create a Trust between two Unrelated Parties

To identify potential deal killers defects in the target and avoid a bad business
transaction.

To gain information that will be useful for

Valuing Assets

Representations & Warranties for Indemnification

Negotiating Price Concessions

Why Due Diligence is Important for M&A.Cont

To verify that the transaction complies with investment or acquisition criteria.

To Investigate & Evaluate a Business Opportunity
It Involves an analysis carried out before acquiring a controlling interest in a
company.

DEFINITION

OBJECTIVE
OF DUE
DILIGENCE

Objective of Due Diligence

To ascertain the appropriate

purchase price & and the
method of payment.

To determine details that may

be relevant to the drafting of
the acquisition agreement,

To evaluate the condition of the

physical plant and equipment; as
well as other tangible and
intangible Assets
To determine compliance with
relevant laws and disclose any
regulatory restrictions on the
proposed transaction

To evaluate the legal and

financial risks of the
transaction

To analyze any potential antitrust

issues that may prohibit the proposed
M&A

To discover liabilities or risks that

may be deal-breakers

TYPES OF
DUE DILIGENCE
OVERVIEWS

Types of Due Diligence Overviews Cont..

BUSINESS DUE
DILIGENCE

Operational Due Diligence aims at the assessment of the functional

operation of the Target Company.

Operational Due
Diligence

Strategic Due
Diligence

Strategic Due Diligence tests the strategic rationale behind a

proposed transaction and analyses whether the Deal is commercially
viable, whether the targeted value would be realized

Intellectual Property Due Diligence Review & diligence of

Intangible Assets like Patent, Copyright, Design, Trademark , Brands
etc. getting greater importance.

Technical Due
Diligence
Technology Due Diligence Technology Due Diligence considers
aspects such as current level of technology, Companys existing
technology, further investment required etc.
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Types of Due Diligence Overviews Cont..

BUSINESS
DUE
DILIGENCE

HR Due Diligence aims at People or related issues. Key managers

and scarce talent leave unexpectedly.

HR Due Diligence

Environmental Due Diligence analyses environmental risks and

liabilities associated with an organization .

Environmental Due
Diligence
It is often undertaken during the information technology
procurement to ensure that risk are uncovered.

Information Security
Due Diligence
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Types of Due Diligence Overviews Cont..

LEGAL DUE
DILIGENCE
Legal Due Diligence
A Legal Due Diligence covers the Legal Aspects of Business
Transaction liabilities

of the Target Company, potential legal

pitfalls and other related issues. Legal Due Diligence covers

intra-corporate and intercorporate transactions.

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Types of Due Diligence Overviews Cont..

FINANCIAL
DUE
DILIGENCE

Financial Due Diligence provides peace of minds to the both

Corporate and Financial buyers, by analyzing and validating
all the financial, commercial, operational and strategic
assumption being made.

Financial Due
Diligence
Financial Due Diligence includes review of accounting
policies , review of internal audit procedure, quality and
sustainability of earning and cash flow, condition and value
of Assets, potential liabilities and tax implication on Deal
Structure.

13

WHEN DUE
DILIGENCE BECOMES
RELEVANT???

14

When does Due Diligence become relevant?

Identifying
Deals

Evaluating
Deals

Deal Strategy Validation

Executing
Deals

Structuring and Negotiating issues

Matters to be included in Shareholders /

other agreement

Value Driver Identification

Identifying black holes

Representation and warranties / indemnities

involved

Harvesting
Deals

Making
Deals
Successful

Valuation

Design

tax

efficient

structures

for

acquisitions and disposals

Planning exit strategies

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KEY FOCUS AREA IN

DUE DILIGENCE

16

Financial Due Diligence Cornerstone of

Every Deal
GOAL - Analyze and validate financial, commercial,

operational and strategic assumptions underpinning a Deal;

Focuses on historical results to form a view of future and confirm there are no
black holes;

Key outputs:

Quality of earnings

Quality of net assets and working capital

Confirms or provides business model assumptions

Identifies risks and possible mitigators, via representations & warranties,

purchase price adjustments and completion reviews

Generates negotiation points to support your offer and refute counter

arguments; Definitions / Business Conduct Issues / Indemnifications
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Financial Due Diligence typically focuses on.

Trading Results segment

wise and identification of
Extraordinary/ exceptional
items, if any.

Gross Margins and

EBITDA analysis.

Group company

transactions
and dependence this would highlight
Separation / Stand Alone Issues.

Review of Internal Control

and MIS systems

Impact of Discontinued
operations.

Specific regulation for business /

industry
Management
&
Employees and their
Relationship

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Direct and Indirect Tax Due Diligence

GOAL - Evaluate potential tax implications of
the transaction and tax position of the Target;

Complex tax and regulatory regime in most Asian countries;

Different legal structures and industry segments have different tax risk profiles;

Key outputs:

Identifies tax risks as well as compliance status of Target

Advise on how identified tax exposures can be mitigated

Provides optimal financial and tax structure for the proposed deal

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Tax Due Diligence Typically Focuses On..

Status of Direct and Indirect
tax assessments.
Review of audits carried out
by
the
respective
tax
authorities

Review of the claims made by

the tax authorities and the
responses made.

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Market Due Diligence

GOAL - Assist in understanding
and prospects of the market
wishes to enter in;

the condition
a Company

Typically involves a combination of desk research, interviews with target

management team, key trading partners and industry experts;

Key outputs:

Issues in respect of achievability of business plan projections

Targets positioning and competitiveness

Target specific market and industry related issues

Identifies strategic value creating opportunities

Highlights Exit risks and opportunities

21

Operational Due Diligence

GOAL - Gaining a coherent overview of a
Targets operations

Covers full scope of business operations from supply chain and logistics to
manufacturing and commercial activities;

Ensures that sufficient work is done on some of the operational assumptions that
are key to the success of a deal;

Key outputs:

Assess operational effectiveness

Identify and quantify opportunities for operational improvement and

develop action plans to deliver against these opportunities

Assess existing management structure and provide insight on

personnel related issues

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IT Due Diligence
GOAL - Evaluation of IT security &
controls and business process issues

Particularly important for M&A in the IT services sector;

Key outputs:

Assess existing IT infrastructure and future needs

Provides inputs for planning integration of systems and applications

Highlight key business process issues, such as in purchases & payables cycle,
revenues & receivables cycle

Assess security & controls to ensure data integrity, availability and confidentiality

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HR Due Diligence
GOAL - Qualitative evaluation of existing staff
including HR policies

Typically covers pension and employee liability valuation, payroll costs validation,
employment termination costs, compensation and benefit alignment costs

Key outputs:

Assess existing levels of employee proficiency against industry standards

Highlight redundancy issues

Assess potential for redeployment of staff

Analyses of industrial relations

Assess employee compensation, including retirement benefits

24

Types of Due Diligence Reviews Purpose

Buy Side Diligence

(For ascertain what buyer are buying )

v/s
Sell Side Diligence
(Issues on which buyers can negotiate)

25

Buy side Due Diligence

Financial analysis to support opinions and conclusions.

Identification of hidden value in the target.

Highlighting post-acquisition / integration / separation issues.

Using expert resources in the target country to identify local risks and issues.

Identifying areas that may impact the exit strategy of the equity provider.

Analysing the sustainability of earnings and cash flows.

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Sell side Due Diligence

Assists the vendor by providing an upfront independent review.

Highlights sale and purchase agreement issues early that may become negotiating
points or areas for warranties/indemnities.

Ensures a level playing field by providing all potential purchasers with objective
information.

Reduces the level of due diligence procedures that potential purchasers need to
perform.

Expedites the deal timetable by avoiding lengthy negotiations and disruption to the
vendor.

Reduces the risk of last minute value erosion and avoid lengthy re-negotiations.

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Types of Due Diligence Reviews Access Levels

Full Access
Full access to the target management, staff, accounting, financial and legal data.

Limited Access
Limited access to the target management, staff, accounting, financial and legal
data.

No Access
Strictly controlled environment, typically based on publicly available data.

Carve Out
Strictly limited to the part of business proposed to be sold.

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What should the methodology be to Generate

following key outputs

Identify potential risks associated

with the transaction & the mitigating
factors

Identify key deal issues and deal

breakers and determine possible
reductions in the purchase price

Attain complete understanding of

the business and the assets

Assess integration and other post deal

matters
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DUE
DILIGENCE
PROCESS

30

Typical Diligence Process

Pre-Fieldwork

Fieldwork

Review Background
Material

Visit Data room

Consider Preliminary
Structure

Assist with letter of

Intent
Develop workmen and
info Request List

Review Audit Work Paper

Visit Target Company and
Interview Management
Review financial model of
Target Company

Post-Fieldwork

Preparation of Report
Finalize Structure
Support Integration Plan
Read and Comment on
Sale Agreement

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Documents To be checked in Due Diligence

Processes
Basic Information

Financial Data

Important
Business
Agreement

Litigation Aspects

IPR Details

Marketing
Information

Internal Control
System

Taxation Aspects

Cultural Aspects

Environmental
Impact

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COMMON
DILIGENCE
ISSUES IN
INDIA
33

Common Diligence Issues in India

Inappropriate revenue
recognition
Unsophisticated

financial

reporting system
Improper cutoff and
rollover impact;

Inadequate reserves and

reversal
of
reserves
including inventory

Improper cutoff and

rollover impact;

Charge backs, rebates

and returns

Issues for representation

and warranties from the
buyer

Related party transactions

stand alone issues
Implications of Regulations,
Taxes & Duties based on
deal structure

Financial & Restrictive

Covenants
in
agreements / legal
documents

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35

Some Practical cases

When Dai-Ichi bank of Japan merged with Nippon Kangyo to form the then

biggest bank in the world called Dai-Ichi Kangyo, the two company
executives found even the definition of the word, loan differed between
the banks!

They had to put

out a 200-word glossary explaining the meaning of

various banking terms before they could even start!

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Some Practical cases

Cont

DAI ICHI AND RANBAXY DEAL

Dai Ichi Sankyo paid $4.6 B for 63% of Ranbaxy

WROTE DOWN

REASON:

A YEAR LATER IT

the value of the acquisition by $3.6 B.

They did not know the depth and extent of Ranbaxys woes and full details of

the Food and Drug Administration (FDA) investigation into Ranbaxy. In fact in 2009 FDA
had shut down reviews of all pending or future drug applications from Ranbaxys Ponta Sahib
plant. The first-to-file atorvastatin (Generic for Lipitor worlds largest selling drug) was the
greatest attraction for Dai Ichi and that was fraught with many problems.

DAI ICHI HAVE MADE INADQUEATE DUE DILIGENCE STAGE AND RESULT THEY EARN
HUGE LOSS.
37

Some Practical cases

Cont

HCL AND AXON DEAL

Infosys and HCL bid for Axon in Sep 08, HCL countered Infosys bid of 600 pence
with an aggressive offer of 650 pence;

INFOSYS WITHDREW AND HCL TOOK IT OVER

NOTE: HCL did make the acquisition work by doing all the right things main one by
eating the ego!
They reverse merged HCL teams into AXON as AXON was a high performance team and
they were better than HCL thus HCL Axon was born.
HCL DURING HR DUE DILIGENCE UNDERSTOOD THE FACTS THAT AXON TEAM
HAS HUGE POTENTIAL AND DEAL CREATE SYNERGEY FOR HCL-AXON.

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In SummaryResult of the Due Diligence

Identification of deal breakers.

Adjustment to pre-diligence valuation.

Negotiation support.

Conditions in Share Purchase Agreement (SPA).

Representations and Warranties.

Inputs for post deal action points.

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In SummaryDue Diligence Focuses On.

Quality of
Assets

Quality of Earnings
& Cash Flows

Separation /
Structuring /
Integration Issues

Potential
Liabilities &
Commitments

Tax and Other

Regulatory Issues

Other stand
alone issues

Co-ordination with other advisors and issues identified by them

Industry and market issues
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Due Diligence V/S Audit

PARTICULARS

DUE DILIGENCE

AUDIT

Scope

Includes not only Financial Analysis but also

business plan, sustainability of business plan,
future aspects, corporate and management
structure and legal issues.

Limited To Financial
Analysis

Data

Covers future growth prospects in addition to

historical data

Based on Historical data

Mandatory

Mandatory based on Transaction

Mandatory

Assurance

Negative assurance i.e. identification of Risks if

any

Positive assurance i.e. True

and fairness of the financial
statement

Type

It is required for future decision

Post mortem analysis

Nature

Varies according to the nature of Transactions

Always uniform

Repetitiveness

Occasional event

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Recurring event