Due diligence is the investigation or exercise of care that a reasonable business or person is normally expected to take before entering into an agreement or contract with another party or an act with a certain standard of care.
It can be a legal obligation, but the term will more commonly apply to voluntary investigations. A common example of due diligence in various industries is the process through which a potential acquirer evaluates a target company or its assets for an acquisition. The theory behind due diligence holds that performing this type of investigation contributes significantly to informed decision making by enhancing the amount and quality of information available to decision makers and by ensuring that this information is systematically used to deliberate on the decision at hand and all its costs,
♦ Due diligence is a systematic way to analyze and mitigate risk from a business or investment decision.
♦ An individual investor can conduct due diligence on any stock using readily available public information.
♦ The same due diligence strategy will work on many other types of investments.
♦ Due diligence is applied in many other contexts, for example, conducting a background check on a potential employee or reading product reviews.
Due diligence is performed by equity research analysts, fund managers, broker-dealers, individual investors, and companies that are considering acquiring other companies. Due diligence by individual investors is voluntary. However, broker-dealers are legally obligated to conduct due diligence on a security before selling it.
When considering investing in a startups, some of the steps are appropriate while others just aren't possible because the company doesn't have the track record. Here are some startup-specific moves.
♦ Include an exit strategy. More than 90% of startups fail. Plan a strategy to recover your money should the business fail.
♦ Consider entering into a partnership: Partners split the capital and risk, so they lose less if the business fails.
♦ Figure out the harvest strategy for your investment. Promising businesses may fail due to a change in technology, government policy, or market conditions. Be on the lookout for new trends, technologies, and brands, and get ready to harvest when you find that the business may not thrive with the changes.
♦ Choose a startup with promising products. Since most investments are harvested after five years, it is advisable to invest in products that have an increasing return on investment (ROI) for that period.
♦ In lieu of hard numbers on past performance, look at the growth plan of the business and evaluate whether it appears to be realistic.
As a buyer considering a potential acquisition, it’s important for you to not only identify a solid company that aligns with your overall business objectives, but also to acquire it at a fair price. Proper due diligence provides an objective and in-depth assessment of key areas that a buyer should consider before moving forward with the transaction. For example, performing various financial analyses will help the buyer assess specific key risks involving the quality of earnings, cash flow, assets, liabilities, and working capital.
In addition to shedding light on the target company’s finances, the due diligence process will provide an inside look at strategic and operational characteristics of the company that may make the deal more attractive or take it off the table altogether.
Post-acquisition, the intel acquired through the due diligence process will help the buyer understand the driving factors important to ensuring growth and success in the future. With this information compiled, the buyer should be in a position to make educated decisions as they take the company forward.
From a strategic and operational perspective, performing due diligence will reveal how operational costs and decisions are affecting the company’s bottom line and expose potential weaknesses in personnel structure or internal systems. Having a wholistic understanding of the financial, strategical, and operational aspects of the target company will increase your chances of a successful transaction and maintaining your valuable investment well into the future.
In most cases, a motivated seller’s goal is to close a successful transaction at the highest price possible. Setting aside appropriate time to perform sell-side due diligence before you go to market will give you a realistic valuation for your company and provide accurate information for you to present to potential buyers before you begin your search.
Sell-side due diligence, when properly planned and executed, often exposes unknown risks to the transaction, which allows the company adequate time to address those risks to prevent them from becoming pitfalls later in the sales process. Identifying issues early on is critical – otherwise you risk being blindsided when they are ultimately exposed by the buyer’s due diligence team, usually during key negotiations. By understanding potential problems upfront, you can help neutralize them and, in some cases, even turn them into positives that will benefit the sale.
If you proactively present a potential buyer with an objective view of the company, you build confidence in the overall value of the investment you are marketing for sale. Doing so should also help you avoid surprises and downward negotiations in price and lessen the potential for lengthy, back-and-forth negotiations after a letter of intent has been signed.
Due diligence is an essential part of the M&A process for parties on both sides of the transaction. However, proper preparation is key, especially if you’re looking to evaluate a complex investment opportunity and avoid a deal that could potentially go sideways.
♦ Operational Records
♦ Financial Statement
♦ Articles of Association
♦ Memorandum of Association
♦ Certificate of Incorporation
♦ Shareholding Pattern
♦ Income Tax Returns
♦ Bank Statements
♦ Tax Registration Certificates
♦ Tax Payment Receipts:
♦ PF / ESI Calculation, Payment & Return Filing
♦ GST Calculation, Payment & Return Filing
♦ TDS Calculation, Payment & Return Filing
♦ Income Tax Calculation, Payment & Return Filing
♦ Statutory Registers
♦ Property Documents
♦ Intellectual Property Registration or Application Documents
♦ Utility Bills
♦ Employee Records
♦ Directors Details
♦ Minutes & Annual General Meeting related records
♦ Loans – Secured & Unsecured
♦ Valuation of Assets & Liabilities
♦ Cash flow & fund flow
♦ Verification of Legal Documents
Due diligence is a process which aids investors and companies to verify, investigate and understand the compliance level of the target company in depth by analyzing all the information and documents provided by the target company and then identify the risks involved in the deal. In addition to the above, based on the business and business model, other operational aspects may be consider.
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