Due Diligence

Overview

A company’s compliance with all applicable laws and procedures is typically verified through due diligence by investors. A corporation typically undergoes due diligence before taking out a bank loan, selling its business, investing in private equity, or engaging in any other type of transaction.

This procedure typically examines the financial, legal, and compliance aspects of the company. An evaluation of all the relevant facts about a business or contract is conducted before a formal contract is signed. It is not just buyers who can perform due diligence on the purchase; sellers can work as well. The Due Diligence process consists of Factual, background, legal, and accounting checks. In order to avoid unpleasant surprises after a sale is closed, it is better to perform due diligence on the business.

Types of Due Diligence

There are three types of due diligence-

Commercial Diligence

The investment’s quality, its commercial potential, and the persons involved are examined through Commercial Diligence.

Legal Matters Diligence

The regulatory difficulties and legal ramifications of both inter- and intra-corporate transactions are examined through Legal Matters Diligence.

Finances Diligence

Finance Diligence carries out a thorough examination of the target company’s internal controls, audit procedures, accounting rules, and tax compliances. It also supports the company’s operational, financial, and commercial front.

What Elements of a Due Diligence Report Are Crucial?

A few crucial components of a due diligence report are as follows:

Financial Aspect: Ratio analysis and key financial facts must be included in the report to comprehend the target company’s overall situation 

Viability: It is important to examine the business and financial strategies of the target company to determine its viability.

Personnel Considerations: The competence and reliability of the company’s management must be thoroughly evaluated and mentioned in the Personnel Considerations.

Environmental Considerations: All firms are dependent on their surroundings. Therefore, it is crucial to research the environment and determine its effects on the firm.

Crucial Component: The due diligence process is evaluating the technology that the organization has access to at any given time. Making a decision about the next step would be much assisted by such an evaluation.

Liabilities: The report should account for any legal disputes, regulatory problems, or any current and possible liabilities that the company may face.

What Procedures Does a Corporation Follow Throughout Its Due Diligence?

The following steps make up a company’s due diligence procedure:

Evaluation of MCA Documents

The process of Due Diligence begins at the Ministry of Corporate Affairs (MCA). If one wants to know about a company, then one can check the master information on a company which is available to the public on the website of the Ministry of Corporate Affairs. Access to all documents submitted to the Register of Companies is also available. However, it is not free.

In general, this information from the MCA website is first checked. The data and paperwork obtained in this step consist of

• Organisational Data
• The incorporation date
• Authorized funds
• Paid-up capital
• when the most recent annual general meeting was held
• The most recent balance sheet’s date
• The situation of the business
• Director Detail
• The company’s directors
• The day that directors were appointed
• Registered charges
• The company’s secured lenders’ information
• Number of secured loans
• Documents
• The incorporation certificate

Association bylaws

The MCA also provides the opportunity to download and examine the company’s financial data and other documents related to other elements of the business. An examination of the company’s MCA records would provide a good understanding of the company’s operations.

Evaluation of the Articles of Association (AOA)

Identifying the different classes of equity shares and their voting rights requires an analysis of a company’s AoA during the due diligence process. The articles of association of a firm may forbid the transfer of shares. Therefore, it is important to thoroughly review the AoA before deciding on the share transfer procedure.

Evaluation of the Company’s Statutory Registers

Private limited companies must maintain statutory registers for share transfers, share allotments, board meetings, directors, and so forth under the Companies Act of 2013. As a result, it is necessary to review the statutory registers of a company to gather and verify information on directorship and shareholding.

Evaluation of the financial statements and the book of accounts

It is mandatory, as per The Companies Act of 2013, that businesses retain complete transaction records and a book of accounts. Financial statements must be compared with audited and validated information on specific financial transactions. The following issues must be considered when preparing a Due Diligence report:

• Examining the bank statements for accuracy
• Assessment and verification of all assets and liabilities
• Confirmation of the cash flow data
• Comparison of all financial statements’ accuracy with transactional data 

Evaluation of Taxation Issues

All factors related to the taxation of a company must be carefully examined during the Due Diligence process. This guarantees that there will be no tax obligations made against the company in future. These factors related to the company’s tax situation must be examined when creating the report:

• The submitted income tax return
• Income tax paid to date
• Calculating the company’s income tax obligation
• filed ESI/PF returns
• ESI/PF contributions
• Calculating ESI and PF payments
• The VAT, GST, and service tax returns submitted
• Payments for the VAT, service tax, and GST
• The foundation for calculating payments for the GST, service tax, and VAT
• Returns TDS
• Payment of TDS
• Calculating TDS

Evaluation of Legal Aspects

To determine if the business has any unresolved legal issues, litigation brought by or against the business, and a legal investigation into the company’s real estate portfolio, a trained legal professional needs to conduct a thorough legal audit of the business.

• No secured creditor has objected to the sale of the business
• Verification of the court filings and, if any, court documents
• Evaluation of operational elements

During the process, it is crucial to gain a thorough understanding of the company’s operations, business model, and operational information. There must be a thorough review of all operational components, including site visits and employee interviews.

 The following items must be discussed and recorded during the review of the operational aspects:

• Business strategy
• Number of personnel
• Number of clients
• A production’s details
• Vendor details
• Machinery details
• Utilities

Advantages for Conducting Finance Due Diligence

Capitalization

In order to determine how big and volatile the company’s market is, it is a requirement to conduct a thorough comparison and analysis.

Industries and Business Rivals

It is crucial to compare and research the boundaries of the rivals in order to understand the target company.

Considering Risks

It helps in gaining knowledge about general industry risks and risks unique to a given company; it also warns against pertaining risks and unforeseen threats to the business.

Visionary

It is good to know the company’s future financial prospects; Finance Due Diligence helps in that as well.

Importance of Due Diligence

Here is some importance of Due Diligence:

• Mergers and Acquisitions: It is important to conduct due diligence from both the client’s and the dealer’s perspectives. Consumers investigate financials, litigation, patents, and a wide range of important information, while sellers focus on the experience of the buyer, the financial capabilities to close the deal, and the ability to honour commitments made.
• Partnership: Due diligence is necessary to establish alliances, connections, business mergers, and other such partnerships.
• Joint Enterprise And Collaborations: Assuming that the opposing company’s position addresses whether their own supplies are adequate when two companies merge, there are questions about the reliability of the combined entity.

Frequently Asked Questions