[Expert Corner Series] Due Diligence Checklist and What is to be done during Due Diligence by Riddhi Joshi- PART-V | Corp Comm Legal on Corporate Law

This article will address questions such as what information must the team conducting the due diligence request for from the target entity, how must the team approach the information provided by the target, and what should they look for in the piles of data supplied to them. The article concludes with providing a sample checklist for the due diligence team (taking acquisition of a company as an example), depending on the nature of the due diligence being conducted.

 

While conducting a due diligence process, it is the responsibility of the team conducting it to approach the matter holistically. While an online data room makes matters easier, the team must know the appropriate questions to seek from the target. Depending on the purpose and intent behind conducting the due diligence, there are numerous factors and aspects to consider. Here, we touch upon few important aspects in this regard:

 

a)      Financials

 

The financial information of the target company is probably the most defining feature of the due diligence. It is necessary to appropriately value the physical assets and liabilities of the target company, in the short as well as the long run. In addition to assessing indebtedness, the team must also identify revenue streams, and study the range and diversity of items contributing to the revenue.

 

Another aspect the due diligence team must consider is projection of profits as well as the estimated earnings of the company in the foreseeable future. The team must analyse the basis of these projections and the reasonableness of the profits to increase or decrease over the course of time. The regularity of conducting internal and external audit must also be looked at.

 

It is a good rule of thumb for financials to be assessed over the course of the last three years, broken into 30-day, 60-day, and 90-day periods.

 

With respect to receivables, it is a sign of healthy financials for the company if it has a certain amount marked receivables. It would ensure sustained cash flow over a period of time. However, the age of receivables would be a give-away in terms of the ability of the company to recover costs from customers and distributors.

 

Last but not the least, the due diligence team must also look into the insurance coverage of the target company and the premiums do.

 

b)      Real Estate

 

The team conducting the due diligence must pay close attention to the real estate holdings of the target company. If the company holds leased property, the team must ask for the lease agreement to analyse the tenure of the lease.

 

c)      Intellectual Property

 

The target company must provide a list of patents, trademarks and copyrights (along with other applicable IPR), including those pending with the appropriate authority. The team must study the license agreements whether the company is the licensor or the licensee. The target company also ought to provide details pertaining to investment in research and development. The team must also analyse the steps taken to protect the IPR that the target company holds, be it through clauses in agreements, effective cyber security measures, etc.

 

d)      Taxes

 

An important aspect of the DD process is to analyse the tax liability of the company. The taxes must be up-to-date and properly calculated. A report by the auditors of the company would also prove useful.

 

e)      Compliance with statutory requirements

 

In terms of complying with statutory requirements of commercial law, the team conducting the due diligence requires the Memorandum and Articles of Association and other relevant documents of incorporation. The team must be provided with all the statutorily required documents such as the registers / minutes of board and shareholder meetings. A list of all the security holders, with class and number would also be required.

 

In addition, the target company must provide all corporate / commercial agreements to which it is a party, for example, joint venture, partnership, distribution and franchise agreements, where applicable.

 

f)       Legal issues

 

The Legal due diligence would require the team to be provided with all the records of litigation, whether pertaining to IPR, real estate, or labour disputes. The legal due diligence would serve the purpose of estimating the liability of the target company with respect to the pending / threatened litigation.

 

g)      Human Resources

 

A human resources DD would exhaustively cover the salaries and benefits employees at all hierarchies are eligible to receive. It would also include analysing the organisational structure and the details of all employees. All the employment / consulting contracts of the target company with the employees / contractors would be analysed to study the various clauses.

 

If applicable, this would also extend to any labour union contracts. The Human Resources DD would also include an enquiry into the HR policies, with respect to, inter alia, the leaves, prevention of sexual harassment, termination, etc.

 

h)      Environment

 

An environmental DD is increasingly becoming a crucial component. It would assess whether all necessary environmental permits have been received by the company and whether they are up-to-date. In addition, the team must also assess the means of disposal of waste material.

 

i)       Marketing

 

This aspect of the due diligence would necessitate a thorough understanding of the marketing strategy (both online and offline) adopted by the target company. This would include a schedule on advertising costs, price lists, and customer trends. All contracts with sellers and other purchase and distribution agreements should be supplied. Furthermore, a report detailing trends on the market and other consumer-related risks would also be useful.

 

A checklist could be prepared on the response by the target company as under:

 

	Will Provide	Will Not Provide	Does Not Exist
Intellectual Property
Copies of all trademarks, patents, copyrights, and other intellectual property
Schedule of all applications containing date of application, duration, countries where registered etc.
Licensing agreements, (whether target company is a licensee or licensor), as well as agreements with software consultants
Procedures and details of cyber security measures to maintain the confidentiality of these IPR
Any report valuing the target company’s intellectual property
Financial Health
Copies of all audited and unaudited financial statements, including but not limited to profit-and-loss statements, balance sheets etc.
Details of accounts receivable in terms of age
Projections of profits and estimated cash flow
List of all assets owned by the target company
Details of all liabilities such as short-term and long-term debts
Insurance Policies and the premium on these policies
Tax
Copies of tax returns and filings
Report on the accounting treatment of the tax
Real Estate
List of all property possessed by the target company, whether through ownership or lease
Calculation of the asset value and the projected depreciation
Copies of all lease agreements, whether target company is a lessor of lessee
All sale deeds, whether target company is a vendor or buyer
Company-Related Matters
Copies of Memorandum of Association and Articles of Association
Copies of all shareholder agreements, and other agreements pertaining to similar transactions such as conversions, redemptions, etc.
Copy of register recording minutes of board meetings, shareholder meetings, and meetings of other committees.
Copies of agreements pertaining to any completed or proposed joint venture, partnership, or franchise, or any other form of merger or acquisition.
A schedule of all security holders, with details of class and number of security.
Legal
List of all details pertaining to pending and disposed off litigation or arbitration proceedings involving any KMP of the target company
Details of cases instituted by the target company, along with anticipated outcome of still pending
Human Resources
Organisational chart and details of all employees in terms of year of joining, position, remuneration, etc.
Copies of standard agreements with employees, unions (if applicable), etc.
Human resources policy, including but not limited to leave, sexual harassment, etc.
Composition of committees required by relevant labour and sexual harassment laws
Environment
Copy of all permits and licenses pertaining to relevant environmental clearances.
Details on methods of disposal of waste material.
Marketing
Copies of all agreements will sellers and other purchase and distribution agreements.
Marketing strategy and consumer trends
Price list of products and services
Report on the trends in the market and consumer-related risks.

 

 

Sources

 

1.      Richard Harroch, “A Comprehensive Guide to Due Diligence Issues in Mergers and Acquisitions”, Forbes, March 27, 2019, https://www.forbes.com/sites/allbusiness/2019/03/27/comprehensive-guide-due-diligence-issues-mergers-and-acquisitions/#17912f3a2574.

 

2.      The Forbes MA Group, “Due Diligence Requirements – Checklist”, Forbes, January, 2016, https://forbesma.com/wp-content/uploads/2016/09/Due-Diligence-Checklist.pdf.

 

3.      “What are the Types of Due Diligence”, Corporate Finance Institute, https://corporatefinanceinstitute.com/resources/knowledge/deals/types-of-due-diligence/.

       The author of this post,Riddhi Joshi is a law student at Symbiosis Law School, Pune and is currently intern at Corp Comm Legal under Mr. Bhumesh Verma.

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