DUE DILIGENCE
DEFINITION
Due diligence of a company is conducted to check for any regulatory/process compliance within the organization. It is usually conducted before any kind of private equity investment/business sale/bank loan etc. During a due diligence process the legal/financial and compliance aspects of the said company/ organization are reviewed and documented. All the material facts of a deal/contract are examined and checked before both the concerned parties sign the contract. Due diligence as a process is conducted by both buyers and sellers.
THREE DIFFERENT TYPES OF DUE DILIGENCE
1)BUSINESS DUE DILIGENCE
Business due diligence looks into the quality/business prospects of an investment and the parties that are involved in such a transaction.
2) LEGAL DUE DILIGENCE
Legal due diligence looks into the legal issues/aspect/regulatory issues involved in intra-corporate/inter-corporate deals and transactions.
3) FINANCIAL DUE DILIGENCE
Financial due diligence is used to validate the financial/operational/commercial assumptions and calculations taken by the company. This procedure involves a complete review of audit and accounting practices & policies/internal controls/ tax compliances of the said company.
The findings that are discovered from the process of due diligence are then summarized and put in a report which is called a due diligence report.
IMPORTANT ASPECTS OF DUE DILIGENCE
a) FINANCIAL ASPECTS
The due diligence report must always rely on important financial data & precise ratio analysis to understand the entire financial picture that has been related to the target company.
b) OVERALL VIABILITY
To assess the viability of a said company the business and financial plans have to scrutinized in a thorough manner
c) PERSONNEL CHECK
A due diligence report must consist of a detailed assessment in regards to the credibility/capability of the business owners.
d) ENVIRONMENTAL ASPECTS:
No company/organization can separate itself from the business environment around it. Therefore, a due diligence report studies the business environment and how it impacts the said company.
e) TECHNOLOGICAL ASPECTS:
An assessment of the the technology available with a company at any given point of time is another important aspect of the due diligence report. This kind of assessment helps a great deal in deciding the future course of action.
f) LIABILITIES:
A due diligence report must consider any existing/ potential liabilities which could be any future regulatory issues/pending litigations etc. the said company may encounter.
DOCUMENTS NEEDED FOR DUE DILIGENCE
- The charter documents of the company
- Any notices, attendance sheets & minutes of board meetings
- Any notices/attendance sheets & minutes of general meetings
- The statutory registers
- Amy legal agreements executed by the said company
- Any RBI related documents
STEPS TAKEN FOR DUE DILIGENCE OF A COMPANY
The due diligence process of a company consists of the points mentioned below:
1) ASSESSMENT OF MCA DOCUMENTS
The due diligence procedure of a company/organization starts with the Ministry of Corporate Affairs (MCA). The website of the Ministry of Corporate Affairs publicly makes available the master data of any registered company. When an individual makes a payment of a small fee, all the documents that have been filed with the Registrar of Companies are available to this individual. Once this information has been acquired from the MCA website it is verified. The list of documents one gets during this step are mentioned below:
a)COMPANY INFORMATION
- The date of incorporation
- Authorized capital
- The paid-up capital
- The date of the last annual general meeting
- The date of the last balance sheet
- Status of the company
b) DIRECTOR INFORMATION
- The directors of the company
- The date of appointment of directors
c) CHARGES REGISTERED
- The details of secured lenders of the company
- The quantum of secured loans
d) DOCUMENTS
- The certificate of incorporation
- The memorandum of association
- Articles of association
In addition to the all of these mentioned above, the financial information of a company or any other filings with the MCA which concern the various aspects of the company can also be downloaded and reviewed. The review of the MCA documents of a company will provide an accurate overview of the company to the concerned person who’s performing the due diligence.
ASSESSMENT OF ARTICLES OF ASSOCIATION (AOA)
It is important to review the articles of association of a company during the due diligence procedure to establish the different classes of equity shares and their respective voting rights. The articles of association of a company can restrict or limit the transfer of shares of a said company. Thus, the articles of association must be studied minutely to decide the process for transfer of the shares.
ASSESSMENT OF STATUTORY REGISTERS OF A COMPANY
Under the Companies Act, 2013, a private limited company needs to maintain various statutory registers in relation to the share transfer/share allotment/board meetings/the board of directors, etc. Thus, the statutory registers of a company must always be scrutinized to obtain and validate the information in regards to the directorship and the shareholding.
ASSESSMENT OF BOOK OF ACCOUNTS AND FINANCIAL STATEMENTS
A company is required to maintain their book of accounts along with detailed financial transactions and information that is required under the Companies Act 2013. These transactions must be audited and verified against the financial statements that have been prepared by the said company. Some of the matters which are important during the preparation of the due diligence report are as follows:
- The verification of bank statements
- The verification and valuation of all the assets and liabilities
- The verification of the cash flow information
- The verification of all the financial statements against transactional information
ASSESSMENT OF TAXATION ASPECTS
The taxation aspects of a said company must be thoroughly scrutinized during the due diligence process. This helps to ascertain that no unforeseen or unexpected tax liabilities are due on the company on a future date. The following taxation aspects of a company must be checked during the preparation of the due diligence report:
- The income tax returns that have been filed
- The income tax that has been paid
- The calculation of the income tax liability by the company
- ESI / PF returns that have been filed
- ESI / PF payments that have been made
- ESI / PF payment calculations
- The GST/service tax / VAT returns filed
- The GST/service tax / VAT payments
- The basis for the GST/service tax / VAT payment calculation
- TDS returns that have been filed
- TDS payments that have been made
- TDS calculations that have been ascertained
ASSESSMENT OF LEGAL ASPECTS
A complete legal audit of the company must be conducted by a certified legal practitioner to ascertain if there are any pending/incomplete legal actions/suits/liabilities by or against the said company. The below mentioned aspects must be reviewed as well during the due diligence process:
- Legal due diligence for all the real estate properties owned by the company.
- A no objection certificate from a secured creditor for the transfer of the company.
- Verification of the court documents and the court filings, if any are applicable
ASSESSMENT OF OPERATIONAL ASPECTS
It is important for a prospective buyer to obtain a complete understanding of the business operations/business model and operational information during the process. A thorough review of the operational aspects must be all-encompassing and must include site visits and employee interviews. Mentioned below are the points that should be covered and documented during the review of the operational aspects:
- The business model
- The number of employees
- The number of customers
- All the production information
- Complete vendor information
- Complete machinery information
- Complete information about utilities
Our team of tax and legal experts at ACE ALLIANCE will assist and help you to review all the corporate documents such as organization charts/ Articles of Association/ Company bylaws and the company minute books. Our team will delegate the right experts from multiple business verticals to help you complete your due diligence report. We will then share the due diligence report and answer any further queries you may have for the same.