Overview of Due Diligence

The term "due diligence" defines the general responsibility for the exercise of ordinary care in any functioning of the business. All efforts, remuneration and analysis to be made by the person or entity of the corporation, in order to evaluate or carry out all the essential arrangements or contracts, are part of this process. It is important to carry out different types of business and transactions in the financial world. Lets have a deep dig at the process of Due Diligence and its importance of an organization.

Understanding the Due Diligence

Due Diligence is a process of:

• Analysing several aspects to estimate the commercial potential of the entities;
• Assessing the financial viability of an entity in terms of the assets and liabilities at a comprehensive level;
• Examination of the operations and verification of the material facts related to the entity about any proposed transaction.

Due diligence contains a complete understanding of all the obligations of the company. The rights and responsibilities, the leases, the lawsuits filed, the guarantees, the guarantees, the debts are all carefully examined in order to improve the functioning of the company on the market. Undergoing, the method of Due Diligence during a company means doing homework on any potential deal and calculating the risks involved in the agreement. 

Primary Objectives and Scope of Due Diligence

The Primary Objectives of the method of Due Diligence is as follows:

• To recognize the strong point and also to determine threats and weaknesses
• To take a good valued decision about any investment
• To make a smooth decision
• To develop a sense of confidence among shareholders
• To provide a good security level in a transaction
• Collect all the material information required

The Scope of the method of Due Diligence is as follows:

• It depends on the needs of the person who are involved in the investments, addressing issues which are not covered anywhere, areas of a major threat, and identifying new opportunities.
• In general, it covers all the litigations, compliance, uncovered risks, and future investments.

Types of Due Diligence

The process of Due Diligence differs for various sorts of entities. There are around as many as 25 or more angles of observing and analyzing the day to day affairs of any Company. 

The main kinds are as follows:

Business Due Diligence

This type of Due Diligence typically involves watching the business scenario, quality of parties, and value of the investment. 

This type includes the following:

Operational

This type of Due Diligence examines the operational weaknesses, the functioning including its Target Company, the degradation or updating associated with either the Company's operating process, the economic impact on the Company's operating efficiency.

Strategic

In this type of Due Diligence analysis of a business or transaction, it is thoroughly checked whether a business or transaction is commercially feasible or not. In addition, the position of the company in a competitive environment is carefully studied in order to achieve better results in the industry.

Technology

This type of Due Diligence involves checking this level of technology and therefore the existing level of technology within the company. Whether or not there is a need for any longer investment within the Company.

Environmental

This type of Due diligence involves all environmental risks associated with a corporation. This type includes the identification of risks related to:

• Site assessment;
• Managing the site operation;
• reviewing the history of the sites and the environmental status of the site;
• Control of pollution of the site by regulation.

Human Resource

This type of Due Diligence is primarily concerned with the problems associated with the company's workforce. There are sometimes cultural differences within the Company, which cause small problems within the Company. It is very important to know the important cultural differences of the company in order to create a pleasant working environment within the company.

Ethical

This type of Due Diligence calculates all the moral risks involved within a company. The ethical character of a corporation, the reputation of a corporation, a partner or director or an official is moral or not; these risks are managed in this way.

Legal Due Diligence

This type of Due Diligence focuses mainly on the legal aspects of transactions, legal pitfalls and other legal issues.

Under this type of due diligence, the examination of the following elements is usually carried out:

• Memorandum of Articles or MoA;
• Minutes of meetings of the Board of Directors;
• Copies of all share certificates issued to employees;
• the guarantees of which the Company is a party;
• License Agreements;
• The Loan Agreement.

Financial Due Diligence

This type of Due Diligence involves an analytical study of the business, identification of vital monetary risks, assessment of key corporate issues and key drivers of sustainable profits and cash flows, and potential transaction breakers. Validation of all financial, operational and commercial assumptions is finalized here. The review of the internal audit, the accounting policies, the earnings sustainability, the value of the assets and the structure of the transactions and the review of the economic system is completed within the framework of the Financial Due Diligence.

What are the steps to be followed for conducting the method of Due Diligence?

The process of conducting the method of Due Diligence is as follows:

Assessment of the Documents of MCA

Generally, the majority of the company's due diligence starts with the MCA or the Ministry of Corporate Affairs. All master data on any company is publicly available on the official website. In addition, with the payment of the fee, all required documents of the company concerned are filed with the Registrar of Companies (ROC) made accessible to a person.

The above-provided information from the website of MCA is usually verified first. The documents and information gathered in this step include the following:

• The information of Company;
• The information of Director;
• The registered Charges;
• Documents like the certificate of incorporation, memorandum of association (MOA), and Articles of association (AOA).

Some of the matters relevant to the business and financial Due Diligence process are as follows:

• Verification of bank statements;
• Verification and valuation of all assets and liabilities;
• Verification of cash flow information;
• Verification of financial statements against transactional information.

In accumulation to all the above, the financial information of the company and all other filings with the Ministry of Corporate Affairs about several aspects of the company can be downloaded and further reviewed for conducting Due Diligence:

• Assessment of the Articles of Association;
• Assessment of the Statutory Registers of Company;
• Assessment of the Book of Accounts and Financial Statements of Company.

Assessment of Taxation Aspects

The following characteristics relating to the tax aspect of a company must be checked:

• a return on income tax filed by the company;
• the tax on income paid by the company;
• All GST, service tax and VAT returns submitted by the company;
• GST, service and VAT payments made by the company;
• The basis for the calculation of the GST, service tax and VAT payments.

Assessment of the Legal Aspects

The following aspects are required to be checked during the process of Legal Due Diligence:

• Legal Due Diligence for all the company’s real estate properties;
• No objection certificate from a secured creditor for the transfer of the company;
• Verification of all the court documents and the court filings, if any.

Assessment of Operational Aspects

Following are the aspects that are required to be covered and documented in the review of the operational aspects:

• Business model of the company;
• Number of employees of the company;
• Number of customers of the company;
• Production information of the company;
• Vendor information of the company;
• Machinery information of the company.

What are the documents required for the process of Due Diligence?

The main documents required for the process of Due Diligence are as follows:

• The Certification of Incorporation;
• The Memorandum of Association or MOA;
• The Articles of Association or AOA;
• The Financial Summary;
• The IT Returns of the company;
• Bank Report of the company;
• The certificates of Tax certification;
• The composition of the Shareholding;
• Statutory declarations of the company;
• All the Property records of the company;
• The Intellectual Property Certification or application;
• The Service bills;
• The Environmental audits, license, and permits;
• The Biographical data;
• Labor disputes of the company, if any;
• Employment and loan contracts;
• The Employee benefits documents;
• The Employment manual and policies;
• All the Operational documents related to the list of suppliers of the company, total monthly production capacities, and yield, the backlog of the production, inventory reports, etc.

What are the benefits of conducting the process of Due Diligence?

The benefits of conducting the process of Due Diligence are as follows:

• Administration and Ownership

The complete analysis of who runs the Company.

• Capitalization

Examining how large and volatile is the Company and its market. A contrastive analysis of both is needed.

• Business Competitors and Industries

Complete research and comparison of the boundaries of competitors in the market for a better comprehension of the target Company

• Balance Sheet Review

A Balance Sheet Review of a company helps in interpreting the debt-to-equity ratio.

• Revenue, Profit and Margin Bearings

To examine whether there are any recent trends in the figures which may be falling, rising, or stable.

• Risks

Learn about industry-wide and company-specific hazards. Checking for any current risks and trying to predict any future unforeseen threats later on.

• Capital History, Options, and Probabilities

How long the Company has been dealing in the market. The dealing is for a short- term or long-term. Has there been any steady stock price?

• Expectations

To maximize the profit of the company for the future.

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