Due Diligence

for

Mergers & Acquisitions

11/02/2015
AGENDA

- Why Due Diligence is important for M&A;

 Objective of Due Diligence;
 Types of Due Diligence Overviews;
 When Due Diligence becomes Relevant;
 Key Focus Area in Due Diligence;
 Due Diligence Process;
 Common Due Diligence Issues in India;
 Case Study;
 Summary;
 Conclusion .
DUE DILIGENCE : LEARN FROM
THE PAST, BUT LOOK TOWARDS
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THE FUTURE
 WHY DUE
DILIGENCE IS
IMPORTANT
BEFORE ANY
TRANSACTIONS

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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.

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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

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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.

DUE DILIGENCE IS NOT THE JUDGEMENT MAKING IT IS JUST

BRING OUT ALL FACT TO FORE

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OBJECTIVE
OF DUE
DILIGENCE

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Objective of Due Diligence

To ascertain the appropriate To determine details that may To evaluate the legal and
purchase price & and the be relevant to the drafting of financial risks of the
method of payment. the acquisition agreement, transaction
To evaluate the condition of the
To analyze any potential antitrust
physical plant and equipment; as
issues that may prohibit the proposed
well as other tangible and
M&A
intangible Assets
To determine compliance with
relevant laws and disclose any To discover liabilities or risks that
regulatory restrictions on the may be deal-breakers
proposed transaction

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 TYPES OF
DUE DILIGENCE
OVERVIEWS

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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 tests the strategic rationale behind a

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

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, Company’s existing
technology, further investment required etc. 10
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.

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 WHEN DUE
DILIGENCE BECOMES
RELEVANT???

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When does Due Diligence become relevant?

Making
Identifying Evaluating Executing Harvesting
Deals
Deals Deals Deals Deals
Successful

 Deal Strategy Validation • Structuring and Negotiating issues

• Matters to be included in Shareholders /
 Value Driver Identification other agreement
• Representation and warranties /
 Identifying black holes
indemnities involved
• Design tax efficient structures for
 Valuation
acquisitions and disposals
• Planning exit strategies

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KEY FOCUS AREA IN
DUE DILIGENCE

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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 Gross Margins and  Impact of Discontinued
Extraordinary/ exceptional
EBITDA analysis. operations.
items, if any.

Group company transactions and

Specific regulation for business /
dependence – this would highlight
industry
Separation / Stand Alone Issues.

Management &
Review of Internal Control
Employees and their
and MIS systems
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 the claims made by

Review of audits carried out
by the respective tax the tax authorities and the
authorities
responses made.

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Market Due Diligence

GOAL - Assist in understanding the condition and

prospects of the market a Company wishes to enter in;

 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

 Target’s positioning and competitiveness

 Target specific market and industry related issues

 Identifies strategic value creating opportunities

 Highlights Exit risks and opportunities

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Operational Due Diligence

GOAL - Gaining a coherent overview of a Target’s

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

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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)

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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

Financial Identify potential risks associated

and with the transaction & the
mitigating factors
Taxation

Identify key deal issues and deal

breakers and determine possible
reductions in the purchase price

Legal and
Contingent
Due Operational
Obligation Diligence & Technical

Attain complete understanding of

the business and the assets

Assess integration and other post deal Human

matters Resource
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 DUE
DILIGENCE
PROCESS

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Typical Diligence Process

Pre-Fieldwork Fieldwork Post-Fieldwork

Review Background Visit Data room

Material Preparation of Report

Consider Preliminary Review Audit Work Paper

Structure Finalize Structure

Assist with letter of Visit Target Company and

Interview Management Support Integration Plan
Intent
Develop workmen and Review financial model of
info Request List Read and Comment on
Target Company
Sale Agreement

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Documents To be checked in Due Diligence
Processes

Important Business
Basic Information Financial Data
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

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Common Diligence Issues in India

Inadequate reserves and

Inappropriate revenue Improper cutoff and
reversal of reserves
recognition rollover impact;
including inventory

Issues for representation

Unsophisticated financial Charge backs, rebates and warranties from the
reporting system and returns buyer

Financial & Restrictive

Improper cutoff and Related party transactions
Covenants in agreements
rollover impact; – stand alone issues
/ legal documents
Implications of Regulations,
Taxes & Duties – based on
deal structure

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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 A YEAR LATER IT
WROTE DOWN the value of the acquisition by $3.6 B.

 REASON: They did not know the depth and extent of Ranbaxy’s 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 Ranbaxy’s Ponta
Sahib plant. The first-to-file atorvastatin (Generic for Lipitor world’s 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.

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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 Summary…Result 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 Summary……Due Diligence Focuses On.

Quality of Quality of Earnings Potential

Assets & Cash Flows Liabilities &
Commitments

Separation /
Structuring / Tax and Other
Integration Issues 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

Includes not only Financial Analysis but also

business plan, sustainability of business plan, Limited To Financial
Scope
future aspects, corporate and management Analysis
structure and legal issues.
Covers future growth prospects in addition to
Data Based on Historical data
historical data
Mandatory Mandatory based on Transaction Mandatory

Positive assurance i.e. True

Negative assurance i.e. identification of Risks if
Assurance and fairness of the financial
any
statement

Type It is required for future decision Post mortem analysis

Nature Varies according to the nature of Transactions Always uniform

Repetitiveness Occasional event Recurring event42

CONCLUSION

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The goal of DUE DILIGENCE should be

DEAL MAKING

not

KILLING…

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 Pavan Kumar Vijay
Managing Director

Corporate Professionals Capital Private Limited

D-28, South Extension –I, New Delhi-110 049
Ph: +91.11.40622200; Fax: +91.11.40622201; E: pkvijay@indiacp.com

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