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  • Writer's pictureFeasibility Plus

Due Diligence- What It Is Along With Its Kinds

We often hear the phrase “do your due diligence” but not always do we know what it means. Due diligence (DD) is a process where investors review and evaluate a potential investment opportunity to confirm facts. These facts that are mentioned that are reviewed include all information deemed material such as financial records, comparing the numbers over time, past company performances, etc. The due diligence process essentially evaluates the risks associated with potential offers organisations could invest in, selects the least risky investment opportunity and then develops a risk mitigation plan with the company’s management as a part of the potential investment.

All in all, one could call it a process that has a say in whether or not an organisation or any other investor would invest in your company/idea.

There are 10 main types of due diligence inquiries:

  1. Financial DD

  2. Administrative DD

  3. Human Resources DD

  4. Asset DD

  5. Taxes DD

  6. Legal DD

  7. Intellectual DD

  8. Customer DD

  9. Environmental DD

  10. Strategic Fit

1. Financial DD

Financial DD evaluates the accuracy of the finances shown in the Confidentiality Information Memorandum (CIM) and hence are one of the most important types of due diligence. It involves examining the internal control procedures as well as the company’s order book and sales pipeline, analysis of profit margins and major customer accounts along with fixed and variable costs analysis.

It aims at providing a thorough understanding of the company’s financials including the audited financial statements, unaudited financial statements (with comparable statements of last year) along with the schedule of inventory, debtors, creditor, etc.

2. Administrative DD

Administrative DD gives a clearer picture of the kind of optional cost the buyer would likely incur if they plan to pursue the expansion of the target company. It essentially involves verifying admin-related items (like occupancy rate, facilities, etc.)

3. Human Resource DD

Human due diligence is one of the most extensive ones and essentially includes ESOPs and schedules of grants, analysis of total employees and the current status on the occupied and vacant positions, HR policies regarding all kinds of leaves along with its reviewing, analysis of the salaries and bonuses being paid along with the years of service, analysis of various employee problems (could include pending legal cases with current or former employees if any), all employment contracts (such as NDA, non-solicitation and other agreements too) and lastly, the potential financial impacts of any existing labour disputes or pending grievance procedures.

4. Asset DD

It includes the use of permits, a detailed schedule of fixed assets along with their locations, the lease agreements for equipment, real estate deeds, a schedule of sales and major capital equipment in the span of the past 5 years and lastly, title policies.

5. Taxes DD

Copies of tax returns for the past 3-5 years, documentation related to Net Operating Loss (NOL), information relating to any pending tax audits of the company or any unusual correspondence with tax agencies. These are the things that are reviewed and verified for the documentation of tax compliance.

6. Legal DD

It is of utmost importance and includes the following elements:

  • Minutes of Board Meetings of the past 3 years.

  • Minutes of all meetings or actions of shareholders for the past three years.

  • Copy of all guarantees to which the company is a party along with all the share certificates issued to the Key Management Personnel are needed. Along with those, copies of all bank financing agreements, loan agreements, and lines of credit to which the company is a party.

  • Licensing or franchise agreements.

  • All material contracts.

7. Intellectual Property DD

Due diligence revies schedules of not just trademarks, brand names and copyrights but also of patents and their applications. It also reviews pending patent clearance documents and any pending claim cases by/against the company regarding the violation of intellectual property.

All company has such intellectual properties that can be monetised for their business and can help differentiate their services/products from other companies and competitors.

8. Customer DD

Customer due diligence takes a close look at the company’s lifeblood a.k.a the customer base of the company by analysing the following:

  • Customer Satisfaction Scores and related reports for the past three years.

  • List of major customers that have been lost within the past three to five years along with the possible reason behind them leaving or withdrawing from being a part of the company.

  • Current credit policies.

  • Service agreements and their corresponding insurance coverage.

  • Most importantly, it will analyse the top customers of the company who make the largest total purchases from the company along with the ones with the most assets.

9. Environmental DD

Violation of any major environmental rule by the company can make it susceptible to being penalised by the local authorities. They also could be shut down depending on the extent of the violation. This makes due diligence related to the environment very important.

It also includes verifying the disposal method of the company being in synch with the existing guidelines and regulations, checking to see whether any contingent environmental liabilities are there, reviewing the list of environmental licenses and permits (along with validation of the same) and lastly, reviewing the copies of all notices from the state/local regulatory agencies or EPAs.

10. Strategic Fit.

The investors/acquirers are generally very particular about exercising due diligence in terms of evaluating how well the target company fits with the overall business plan of the buyer.

Some key strategic fit issues that are evaluated by the buyer are if the target has the key personnel which can represent a substantial gain in HR, if the target company is to be merged with the acquirer or another firm the acquirer already owns, if the target has technology and products that the acquirer can profit from and determining the best personnel from both the target and acquirer to manage the merger process.

Now that we know the types of due diligence, we must also know about the process and its application. Stay tuned for more!


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