Upload
gamele-ventures
View
19
Download
1
Embed Size (px)
Citation preview
© Oxford University Press 2011. All rights reserved.
Chapter 4
Due Diligence
© Oxford University Press 2011. All rights reserved.
What is Due Diligence? Implies an activity involving either the performance
of an investigation of a business or person, or the performance of an act with a certain standard of care
Also used to mean a required legal obligation although the term more commonly applies to a voluntary investigation
Examples: Steps carried out by venture capitalists before and
during each investment phase of a start-up company
Precautionary steps taken by one company in deciding whether to acquire another i.e. evaluating whether the buy is good or bad.
© Oxford University Press 2011. All rights reserved.
What is Due Diligence? Banking Industry - To act in a prudent manner in
evaluating credit applications.
Securities Market - Responsibility of underwriters to explain the details of new securities to interested purchasers.
Legal Definition - “A measure of prudence, activity, or assiduity, as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent person under the particular circumstances; not measured by any absolute standard but depends on the relative facts of the special case."
© Oxford University Press 2011. All rights reserved.
Activities of Due Diligence
Financial Statements: Review and confirm the existence of assets, liabilities, and
equity in the balance sheet to determine the financial health of the company based on the income statement.
Management and Operations review: Determine quality and reliability of financial statements to gain
a sense of contingencies beyond the financial statements. Legal Compliance Review:
Check the potential future legal problems stemming from the target's past.
Document and Transaction review: Ensure paperwork of the deal is in order and that the structure
of the transaction is appropriate.
© Oxford University Press 2011. All rights reserved.
Need for Due Diligence
Strengths and weaknesses of the business
Gives a fair value of the investment
Helps in identifying the apparent irregularities
Tool of ensuring that the prevailing system of
checks works
© Oxford University Press 2011. All rights reserved.
What does Due diligence involve?
Historical Financial Data Current Financial Data Forecasted Financial Information Business Plans Minutes’ of Directors’ Meetings and Management
Meetings Audit Paper Work Files Contracts with Suppliers, Customers and Staff Confirmation/ Representations from Financiers,
Debtors, etc.
© Oxford University Press 2011. All rights reserved.
Transactions requiring Due Diligence
Mergers and Acquisitions:
Personnel
Financial Operations
Marketing
Property and Equipments
Business Operations
Strategic Alliances and partnerships
Joint Ventures and Collaborations
© Oxford University Press 2011. All rights reserved.
People Involved in Due Diligence Financial
Legal
Operational
© Oxford University Press 2011. All rights reserved.
Parties interested in Due Diligence
Employees
Trade Unions
Shareholders
Creditors
Vendors
Customers
Government
Society
© Oxford University Press 2011. All rights reserved.
Steps in Due Diligence Process
© Oxford University Press 2011. All rights reserved.
Due Diligence Reporting
Should reflect a fair and independent analysis & evaluation of financial and commercial information
Should ensure collection, analysis and interpretation of financial, commercial and tax information in detail
Should provide properly reviewed and analyzed financial information to bidders and various stakeholders
Should also provide a feedback on auditing of the special purpose accounts.
© Oxford University Press 2011. All rights reserved.
Types of Due Diligence
Financial Due Diligence:
involves evaluating a company’s historical, current,
and prospective operating results as disclosed in its
historical, current and projected financial
statements, tax returns, and other information
Involves analysis of balance sheet, review from
cash to marketable securities, receivables,
inventory, prepaid expenses and other current
assets, as well as the value of fixed assets.
© Oxford University Press 2011. All rights reserved.
Analysis on the liability side includes accounts
payable, taxes, and debt obligations must be
closely examined
Helps in getting a sense of future revenues
Evaluates the underlying assumptions used
© Oxford University Press 2011. All rights reserved.
Legal Due Diligence:
Scrutiny of all, or specific parts, of the legal affairs
of the target company with a view of uncovering
any legal risks and provide the buyer with an
extensive insight into the company’s legal matters
Improves the buyer’s bargaining position and
ensures that necessary precautions in relation to
the transaction are taken
© Oxford University Press 2011. All rights reserved.
Objectives of Legal Due Diligence
Gathering of information from the target company,
Uncovering of the target company’s strong and weak sides, relevant risks and advantages in connection with the transaction,
Minimizing the risk of unexpected situations, Improvement of the seller’s bargaining position, Identification of areas where representations and
warranties from the seller should be obtained in the acquisition agreement.
© Oxford University Press 2011. All rights reserved.
Documents verified
IT law and IT contracts Intellectual property rights Patents, copyrights, and
other intellectual property-related documents
Company law Financing Employment law Data protection law Consumer protection law General contract law Minutes and consents of
the board of directors and shareholders
Confidentiality and invention assignment agreements with employees
Tax and financial documents
Legal disputes and other kinds of conflicts
Marketing practices regulation
National and EU-competition law
Public procurement law.
© Oxford University Press 2011. All rights reserved.
Operational Due Diligence:
Involves the on-site analyses of the target business
daily processes and of how the business operates.
Analysis includes an evaluation of the key
employees, managers, independent contractors,
suppliers and other factors necessary for the
business to conduct normal operations
May also cover investigation outside of the actual
business.
© Oxford University Press 2011. All rights reserved.
Includes examining work centres, material flow, scrap generation, and inventory levels to identify improvements required to improve productivity and profitability
Helps identify and implement changes necessary to increase EBITDA and increasing the multiples due to lower risk.
Involves gathering information on: New product or service creation Markets Competition Sales Targets People/Organizational matters
© Oxford University Press 2011. All rights reserved.
Intellectual Property Due Diligence
Through analysis needed in this area as economies
are increasingly becoming technology driven
process of identifying all intellectual property
assets, verifying ownership and ensuring that such
assets are free of encumbrances for the intended
business use is fundamental to any merger,
acquisition or investment
© Oxford University Press 2011. All rights reserved.
Examples range from the ingredients and
manufacturing process for coke, a closely guarded
trade secret, to the many domestic and
international trademarks owned by multinational
conglomerates such as Tata, HUL, Reliance, etc.
© Oxford University Press 2011. All rights reserved.
IT Due Diligence;
Involves scrutiny of IT systems and processes in
use and ascertaining better ways of deriving
value and leverage from IT assets
Involves: Sending an IT request list to the acquired company Compiling an onsite discovery process outline Conducting a review of the requested materials Scheduling and coordinating the onsite visit
© Oxford University Press 2011. All rights reserved.
Human Resource Due Diligence:
Involves valuing the contribution of HR Helps by:
Establishing a link between organizational objectives and the HR function
Determining HR's influence on the skills and motivation of the workforce
Determining the managers views of the HR function Ascertaining the outcomes produced by the HR deliverables Measuring the adequacy of HR measures, metrics and benchmarks Ascertaining the total cost of the HR function and industry
comparisons Ascertaining the HR team structure, skills and motivation.
© Oxford University Press 2011. All rights reserved.
Areas covered
Organizational culture Executive compensation and “golden parachute”
contracts Collective bargaining agreements and potential
change of ownership liabilities Defined benefit and contribution pension plans Postretirement benefits Retention and severance plans Health and welfare insurance structure and reserves HR functional structure and service delivery HR Information System (HRIS) and Employment Litigation
© Oxford University Press 2011. All rights reserved.
Litigation Analysis
When one company sells or otherwise transfers all its assets to another company, the successor is not liablefor the debts and tort liabilities of the predecessor. Successor may be liable, however, under the following circumstances:
If it has expressly or implicitly agreed to assume liability
If the transaction is a merger or consolidation
If the successor is a “mere continuation” of the predecessor
If the transaction was fraudulently designed to escape liability.
© Oxford University Press 2011. All rights reserved.
Components of Litigation Analysis
Customers -- as well as competitors, suppliers, and other contractors—might sue over: contract disputes cost/quality/safety of product or service debt collection, including foreclosure deceptive trade practices dishonesty/fraud extension/refusal of credit lender liability other customer/client issues restraint of trade
© Oxford University Press 2011. All rights reserved.
Employees -- including current, past, or prospective employees or unions—might sue over: breach of employment contract defamation discrimination employment conditions harassment/humiliation pension, welfare, or other employee benefits wrongful termination
© Oxford University Press 2011. All rights reserved.
Regulators might sue over:
antitrust (in suits brought by government)
environmental law
health and safety law
© Oxford University Press 2011. All rights reserved.
Shareholders might sue over:
Contract disputes (with shareholders)
Financial transactions (such as derivatives)
Investment or loan decisions
Divestitures or spin-offs Fraudulent conveyance M&A scenarios (target, bidder)
Dividend declaration orChange duties to minority shareholders
General breach of fiduciary duty
Proxy contents
Executive compensation (such as golden parachutes)
Inadequate disclosure Recapitalization
Financial performance/bankruptcy
Insider trading Share repurchase
Stock offerings
© Oxford University Press 2011. All rights reserved.
Suppliers might sue over:
antitrust (in suits brought by suppliers)
business interference
contract disputes
copyright/patent infringement
deceptive trade practices
© Oxford University Press 2011. All rights reserved.
Does Due Diligence insure against M & A failure? Helps avoid:
Able to avoid unnecessary losses and expenses
The organization’s governing body is able to demonstrate that it has engaged in effective oversight and
Senior officers of the company avoid job- and bonus-threatening adverse events
© Oxford University Press 2011. All rights reserved.
Due Diligence involving Financial Issues Can lead to significant unbudgeted liabilities and
the diversion of time and energy of key executives
Helps identify fictitious bills and fictitious originals created such as the signature-authority list.
Helps identify dormant bank accounts for they are a breeding ground for manipulative practices.
Unexpected voiding of invoices from the organization’s accounts receivable system should be investigated, particularly if your organization is structured so that people who have the ability to void an invoice also have the ability to receive or issue cheques
© Oxford University Press 2011. All rights reserved.
Due Diligence Involving Organizational Records
Periodic review of the minutes of board meetings needs to be done.
Record retention policies are often advocated across countries as a reliable tool of reference.
© Oxford University Press 2011. All rights reserved.
Due Diligence involving Legal Compliance Helps ensure that the organization is in
compliance with applicable law
Depending on the nature and size of an organization’, professional advisors should be engaged to evaluate the laws and regulations as applicable, and to help management design a due diligence plan
Compliance can be achieved in an orderly, cost-effective and timely manner
© Oxford University Press 2011. All rights reserved.
Due Diligence involving Interaction of Contracts
Involves due diligence of key contracts and agreements, and summarizing and cross-referencing
Critical for future reference
Help in avoiding inadvertent conflicts.
© Oxford University Press 2011. All rights reserved.
Due Diligence involving Information Systems
Helps to get tuned to the rapid shift from manual system infrastructure to technology driven infrastructure.
Ensures adherence to regulatory compliance that are coming into force.
© Oxford University Press 2011. All rights reserved.
Due Diligence involving Key Customers and Suppliers
Strong need to initiate ongoing monitoring of the operations and plans of key customers and suppliers as can reveal important information on its current financial and operational status and near-term future events.
Also reveal a deteriorating financial condition in advance.
© Oxford University Press 2011. All rights reserved.
Effective Due Diligence team
Have members with first hand experience in the industry to which the target belongs
Have members with expertise in different areas such as HR specialists, Functional area managers, individuals with knowledge of national culture, etc. Capable of quickly identifying both the positive and negative aspects of the property to be acquired.
Willing to carry out a site visit to evaluate the current condition of the assets to be acquired; both the physical assets as well as the personnel
Have members who possess excellent negotiation skills Have people who have time to lead the project and
serve as team members
© Oxford University Press 2011. All rights reserved.
Ensure that the diligence team is co-located within a secure environment, such as a corporate headquarters or closer to the target
Be familiar with the strategic and financial rationale behind the acquisition
Train the team to identify and home in on specific issues Develop and communicate rules of engagement
between the diligence team and the target company Make available analytical tools and techniques so the
team can rapidly get its arms around potential synergies and integration challenges
Healthy flow of information
© Oxford University Press 2011. All rights reserved.
Why Due Diligence fails?
Failure to Focus on Key Issues
Failure to Identify New Opportunities and Risks
Failure to Allocate Adequate/ Right Resources
© Oxford University Press 2011. All rights reserved.
Thank you!