What are the Types of Due Diligence?
Meaning of Due Diligence (DD)
Due diligence services are a reference to the examination and assessment of risk of a forthcoming business transaction. It assures that the participants to the transaction have all the required information to move forward with the transaction.
DD is a procedure of investigation and analysis that is carried out before an investment, acquisition or acquisition to assess the worth of the principal subject or determine the existence of any issues to be addressed. It analyzes whether the viability financial of an company concerning its assets and liabilities on a an overall level.
Objective of Due Diligence
The principal goal for carrying out DD
- Retrieving material from the target business;
- To increase bargaining power by utilizing SWOT analyses
- Identifying areas in which warranties and representations are required as well as
- To fill the gap between current and planned
A very crucial and time-consuming process involved in the course of an M&A purchase is due Diligence. Due Diligence is a procedure the buyer must conduct to validate the validity of the seller’s assertions. A possible M&A deal will require a variety of due Diligence.
Types of Due Diligence
Due Diligence (DD) is a complex procedure undertaken by an acquisition company to fully and thoroughly evaluate the business of the target company’s assets, capacities, capabilities, and financial performance. There could be up to 20 or more aspects in due diligence analyses.
The principal types of due diligence inquiries are:
- Administrative DD
Administrative DD is a part of due Diligence which includes analyzing administrative things like buildings, occupancy rates and the number of workstations etc. The purpose of due Diligence involves checking the different facilities owned or utilized by the seller, and determining if all operational expenses are included in the financials. Admin DD also gives a more information about the type of operational expenses that the buyer could be liable for if they decide to expand the business they are looking to purchase.
- Financial DD
The most significant due Diligence includes financial due Diligence, which aims to verify whether the financials presented within the Confidentiality Information Memorandum (CIM) are accurate. Financial DD seeks to provide complete understanding of the financials of the company, including the following the audited financial statements of the past three years, the most recent audited financial statements compared to similar statements from the previous year, projections of the company as well as the basis for these projections, the capital spending plan, inventory schedule and other financial information, such as debtors and creditors and so on.
The process of financial due Diligence is also a process of analyzing the important customer accounts, Fixed and variable cost analyses, evaluation of profit margins, and the examination of internal control processes. Financial DD is also a look at the order book of the company and sales pipeline to produce more accurate (more precise) estimates.
A majority of acquirers have an additional section of financial analysis that focuses on the company’s financial situation, including both long-term and short-term credit, the applicable interest rates and the ability of the company to pay its debt and obtain additional financing in the event of need, as well as an overall analysis and assessment of the firm’s capital structure.
- Asset DD
Another kind of due diligence is known as asset due diligence. Reports on asset due Diligence usually include a thorough list of fixed assets and their places of residence (if it is possible physical verification must be conducted). All leasing agreements, equipment leases, list of purchases and sales of significant capital equipment over the past 3 to 5 years. and actual mortgages, deeds to property titles policies, the use permit.
- Human Resources DD
Human resources due diligence is extensive. It can consist of any that follows:
- An analysis of the total employees comprising current and upcoming positions, vacant positions due for retirement and the period for serving notice
- Review of salaries and bonuses received in the past three years, as well as years of service
- All employment agreements, including non-disclosure, non-solicitation, and non-competition contracts between the employee and the company. If there are a couple of ambiguities in the general contract Any questions or concerns must be addressed.
- HR policies on annual leave, sick leave and other types of rest are evaluated.
- An analysis of employee-related issues like alleged unfair termination and discrimination, harassment and any legal proceedings that are pending with former or current employees
- Potential financial consequences of the present labor dispute, request in arbitration or grievance procedure in the process
- A listing and description of all health benefits offered to employees or welfare policy as well as self-funded arrangements
- ESOPs and grant schedules
- Environmental DD
Due Diligence concerning environmental regulations is crucial since if a company is found to be in violation of any of the major rules, local authorities may apply their rights to penalize the company for the company’s shut down. This makes environmental audits for every property which is leased or owned by the business one of the most essential kinds that are required. These should be reviewed with care:
- The list includes environmental permits and licences and the validation of them
- Copy any correspondence or notices sent by the EPA or local and state regulatory agencies.
- Make sure that the company’s disposal practices are following the latest regulations and guidelines.
- Verify if there are any environmental liabilities or ongoing obligation to indemnify
- Taxes DD
Due Diligence regarding tax liability involves reviewing the tax liabilities the company must pay, making sure that they are properly calculated and avoiding the under-reporting of taxes. In addition, you should verify any tax-related matter that is pending with tax authorities.
Tax compliance documentation and possible issues usually includes checking and analyzing the following:
- All tax return copies, including income taxes, withholdings, and sales tax in the last 3 to 5 years
- Information on any previous or ongoing tax audits for the business
- Documentation on the NOL (net operating loss) or any credit that is not used deducts, carryforwards, or tax credits
- Important, unusual correspondence with tax authorities
- Intellectual Property DD
Every company has intellectual property assets they can utilize to increase the value of their business. These assets intangible are the thing that makes their services and products from those of their competitors. They are often a portion of the most important assets. A few of the elements that should consider in a due-diligence review include:
- Calendar of patents and patent applications
- Schedule of trademarks, copyrights, and trademarks
- Documents for patent clearance pending
- Any ongoing claims action brought from or on behalf of the business with regards to infringement of intellectual property rights
- Legal DD
The legal due diligence process is obviously essential and usually involves a review and examination of the following aspects:
- Copy of Memorandum and Articles of Association
- The minutes of board meetings from the past three years
- Minutes of all meetings , or actions of shareholders during the last three years.
- Share certificates copied for Key Management Personnel
- A copy of all the assurances to which the business is a participant
- All material contracts include partnership or joint venture agreements; Limited Liability Company or operating agreements
- License agreements or franchise agreements
- Copy of any loan agreement and bank financing agreements and credit lines to which your company is a part
- Customer DD
Because customers and customers are the heartbeat of every business The kinds of due Diligence involve a thorough examination of the customer base of the company you are targeting including a comprehensive analysis of the following aspects:
- The top customers of the company are customers who make the highest amount of purchases from the company . As a result, they are”the “largest” in terms of their assets total and are the most important customers regardless of their current spending level with the company.
- Service agreements and the corresponding insurance coverage
- Recent credit guidelines; run and examine your days of sales remaining metrics (DSO) to determine the effectiveness of accounts payable
- Customer Satisfaction Score and other reports over the last three years
- With explanations, a list of any customers that were majorly lost within the last three to five years.
- Strategic Fit
The buyers are usually conscientious about conducting due Diligence when knowing how the prospective company is compatible with the overall business strategy for the prospective buyer. For instance, the private equity firm looking to acquire a new company will want to know if the target is a good fit with the company’s existing portfolio of businesses. A large company considering the possibility of an M&A deal is evaluating how easy (or what the level of difficulty) it will be to successfully incorporate the targeted company with the entire corporate structure of the buyer.
Here are a few of the most important strategic fit issues that buyers take into consideration and analyze:
- Does the target have technologies, products or access to the market that the acquirer does not have and requires or is able to profit from the use of?
- Does the target company have essential personnel who will significantly increase human capital?
- Analyze the synergies between financial and operational advantages that could expect from the integration of the target into the acquirer.
- If the target business is set to merge with the acquirer, or another firm that the acquirer already owns, look over the plan for merger and estimate how long the process of merging will take. Also, determine the costs associated with implementing the actual procedure of combining the two companies.
- Find the most influential people for both from the acquisition as well as the target for managing the process of merger
Additional areas for due diligence studies are IT networks, the issue of bonds and stocks the research and development (R&D) and the areas of sales and marketing. A thorough due diligence process is crucial to the success of any acquisition. If you don’t have a complete and comprehensive understanding of the target business it’s impossible to make informed decisions regarding mergers and acquisitions.
In the event of a merger proposal or in a scenario where stocks of the acquirer’s company form an essential component of the acquisition, the target company could decide to conduct its due Diligence regarding the prospective acquirer.