Due Diligence can be described as an act of investigation, audit, inquiry, or review that is performed to confirm such facts, reality, or details of a matter that is under consideration for the conformity and accuracy of the potential seller and buyer.
Generally, in the world of finance, it requires an examination of financial statements and records before entering into a joint venture with another business. This type of investigation is done by investors and companies that are considering M&A deals. The scope, extent, and breadth of the investigation varies from client to client and situation to situation.
Due Diligence is generally undertaken in case of deals under mergers and acquisitions. The process of due diligence is a time-consuming, and complex process. The failure of most M&A transactions is primarily due to incomplete or improper conduct of due diligence. Thus, it is vital for firms to thoroughly investigate, inquire and understand the real value of the target entity. The need for thorough due diligence arises when the following activities are carried out:
There are majorly three categories in which due diligence can be classified:
Financial Due Diligence can be expressed as thorough research and analysis of another company’s financial records. It is generally done by a business before entering into any legal agreement with another business.
The exercise aims to assess the calculated risks and returns associated with the target company. The following documents and information are considered material while carrying out financial due diligence:
Legal Due Diligence is an investigation of a business by analyzing contracts, agreements, legal papers, material information, and interviewing employees and officers. The three main sub-categories of legal Due Diligence are as follows:
Through legal due diligence, it seeks to understand the target company’s future obligations and risks associated with long-term contracts, lease agreements, workmen compensation liabilities, financial debts, warranties, and claims.
Technical due diligence is a key risk management tool that helps to identify limitations and investment opportunities in transactions associated with mergers and acquisitions. It includes the process of analyzing and evaluating the technologies, products, structures, and processes of the target company prior to effecting a mergers and acquisitions deal. The reasons for technical due diligence may vary. The need to carry out technical due diligence generally arises out of requirements proposed by a venture capitalist company, an investment bank, or an OEM (original equipment manufacturer).
The core areas that must be investigated while preparing the due diligence report are dependent on the type of due diligence that is being carried out. However, some of the core areas that form part of every due diligence report have been highlighted below:
Target company business vitals including the composition of the key managerial personnel, major stakeholders.
Due diligence is a closer form of investigation into the target company’s financial and operational effectiveness. However, while carrying out due diligence, the following challenges are generally faced by the due diligence team:
The following things must be kept in mind while formulating a due diligence strategy:
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