You may have come across the phrase due diligence as a professional, investor or seller / target entity. The importance of availing due diligence services is gaining increasing momentum in India. Let us understand what due diligence is all about.
What is Due Diligence?
Due diligence is an independent detailed investigation or assessment made on the target entity / asset to understand the potential risks involved in a proposed transaction. It involves the evaluation and examination of the claims, risks and benefits of a proposed transaction. This is done by analyzing the origin, functioning and predictable future position of the entity or asset concerned with regards to the proposed transaction.
Although availing due diligence services is usually not a legal requirement, the concept revolves around a simple principle of caveat emptor (let the buyer beware). Whilst the investor is often covered with the representations and warranties made by the seller / target at the time of consummation of the transaction, the idea behind due diligence is to avoid having to make any claims due to non-disclosures.
When does one avail Due Diligence Services?
With the advent of foreign investors, businesses in India are swiftly getting familiar with the necessity, processes and importance of conducting legal due diligence. It is more of a safety precaution before turning any major transaction into a costly mistake. Due diligence may be conducted in the following situations amongst others namely:
- Transactions that include acquisitions, mergers, business transfers, investment in shares or debt, project finance, securitization, real estate transactions, privatization, etc.;
- By groups of employees or trade unions, to check whether they would get bonuses, perquisites or at least their minimum guaranteed salary;
- By scholars, researchers or economists to understand the dynamic nature of market by using few particular entities as a model;
- By target entity itself (also popularly known as vendor due diligence) to understand its own strength and weakness (similar to SWOT analysis) before initiating negotiations on a proposed transaction; or
- By lawyers, accountants and tax professionals amongst others, to analyze the legal, financial, tax and other liabilities.
An investor does a fair amount of analysis and research before investing in any asset. In addition, investors should conduct due diligence through experienced / reputable / top due diligence services firms over claims made by the seller / promoter. Avoiding it could result into a costly mistake for which the investor may have to repent later.
There are several benefits of availing the services of the best due diligence firms in India that can reap paybacks for the investors.
Types of Due Diligence Services
Since due diligence involves the study of the entire functioning of the targeted entity or the asset, it becomes essential to approach the investigation with a multi-dimensional view. This involves providing due importance to the business, legal, tax, financial and other relevant aspects. The ultimate objective is to embrace the benefits and evade from the unexpected liabilities.
Thus, it is necessary to follow different types of due diligence such as:
- Legal
- Financial and accounting
- Tax
- Real estate
- Commercial
- Reputational
- Human resource
- Information technology
- Operations
- Environmental
- Technical
- Insurance
Vendor due diligence: Sometimes, a business owner decides to sell his business or raise funds without assessing the proper condition and drawbacks of the business. By doing so, the promoter will inevitably lower his or her power in negotiation with the investor. In such scenarios, the concept of vendor due diligence service helps the business owner to properly assess the condition of their businesses before approaching investors.
There are several benefits of availing the services of the best due diligence firms in India that can reap paybacks for the investors.
Benefits or Advantages of Due Diligence:
The ultimate aim of due diligence is to determine whether to enter into a particular transaction or not. It is like a prediction based on the available data similar to weather forecasting which helps decide whether to use an umbrella to get somewhere or simply stay indoors.
Similarly, due diligence allows us to decide whether to enter into an agreement at all or attempt to minimize the risks by predicting the possible outcomes and approach them accordingly. Amongst others, due diligence services help the investor to:
- Avoid any losses that could arise due to any non-disclosures during the consummation of the transaction;
- Have an accurate assessment of the potential investment and identify areas for further negotiation and valuation adjustment;
- Verify the information provided and affirm the nature and type of the target entity;
- Identify the deal-killer defects which will affect the investment as a whole;
- Gain necessary information and data that may help in the valuation of assets and liabilities;
- Ascertain the risks associated with the target entity;
- Fix appropriate bidding prices depending on the data and quality of earnings, assets and liabilities;
- Determine whether to enter into the proposed transaction or not;
- Promote good governance by putting the target entity in check;
- Check the credit worthiness of the target entity and to ascertain whether the entity is capable of performing the assigned contractual obligations;
- Mould the securitization of the shares and stocks through appropriate covenants and clauses in the agreement;
- Ensure that the predicted return on investment does not suffer due to losses arising from any non-disclosures;
- Conduct better negotiation of the valuation and covenants / clauses in the agreement;
- Confirm or deny representations made by vendor or any agent;
- Gain educational knowledge on functioning of the market and entities;
- Protect the capital and reputation of the investor and the target; and
- Promote corporate integrity and foster investor and customer confidence.
Disadvantages of Due Diligence:
- It is a lengthy and time-consuming process;
- All data is not necessarily available due to non-disclosure and confidentiality agreements between parties;
- Data may be stored in inaccessible form, or significant data could be lost or unfound or not available for any other reason; and
- It is just a prediction and not an absolute decision as the market conditions are always subjected to unpredictable changes.
Due diligence is a complex process and involves various facets within itself. Thus, it is best to conduct this investigation with the help of experienced and best quality due diligence services firms.
Conclusion
Due diligence is becoming the most preferred method to understand the target entity and market conditions. These assessments uphold the reputation of good whereas showcase the faux. Though it is not legally mandated, it helps us to predict the possible outcomes and make a decision that will benefit the decision-maker. The significance of due diligence is increasing in India and it creates trust among business partners, foreign investors and market participants. Due diligence is a step which a prudent man ought to take before making any investment.
About Leslie & Khettry:
We provide due diligence services across various industries and sectors. We have conducted due diligence on startups, partnership firms, small and medium sized companies, properties across India, listed companies, NBFCs, securitized assets, labour and employee relations, etc. We have garnered considerable experience in conducting legal due diligence with regards to various forms of investments (such as mergers, acquisitions, takeovers, privatization, property investment, equity and debt financing, etc.) by our clientele.