Due Deligence

1. Due Deligence
Meaning
It is a process of investigation, performed by investors, into the details of a potential investment such as an examination of operations and management
and the verification of material facts. It is used to investigate and evaluate a business opportunity. It involves review of Financial & Non Financial records
Importance of due deligence
1) To confirm that the business is what it appears to be
2) To identify potential ‘deal killer’ defects in the target company and avoid a bad business transaction
3) To gain information that will be useful for knowing the valuing assets and/or negotiating price concessions
4) To verify that the transaction complies with investment or acquisition criteria.
Areas/ Types / Classification of DD
Commercial/ Operational
DD
Evaluation of commercial strategic & operational perspective. For example, whether proposed merger would create
operational synergies.
Financial DD Analysis of BOA and other information pertaining to financial matters of the entity
Tax DD The accountant has to look at the tax effect of the merger or acquisition.
Information system DD It pertains to all computer systems and related matter of the entity.
Legal DD To check the compliance with laws and regulation of target.
Environmental DD It is carried out in order to study the entity’s environment, its flexibility and adaptiveness to the acquirer entity.
Personal DD to ascertain that the entity’s personnel policies are in line or can be changed to suit the requirements of the restructuring.
Steps involved in financial DD (or) Areas covered in financial DD
Brief history of target company and background of its promoter Accounting Policies
Review of FST Taxation
Cash Flow Financial Projection
Management and Employees Statutory compliance
Author’s Note: while writing answers in exams, explain all the above points in one-two line each.

2. Hidden liabilities Overvalued assets
 Show cause notice not matured into demand. Maybe material & imp.
 Letters of comfort to Banks & Financial Institutions.
 Tax liabilities Under direct & indirect tax
 Long pending sales tax assess.
 Pending final assess. of customduty
 Agreement to buyback shares at stated price
 Future lease liabilities
 Unresolved labour litigations
 Uncollected/uncollectable receivables.
 Obsolete, slow non-moving inventories or inventories valued above NRV
 Underused or obsolete Plant and Machinery and their spares asset
values which have been impaired due to sudden fall in market value etc.
 Intangible assets of no value
 Litigated assets and property.
 Investments carried at cost though realizable value is much lower.
 Investments carrying a very low rate of income / return.
 Infructuous project expenditure/deferred revenue expenditure etc.
Work Approachto DD
 Reviewing & reporting on the financials submitted by the target company
 Accessing the business first hand by a site visit (if applicable)
 Working through the due diligence process with the acquisitioning company (or) investor by defining the key areas
 Helping prepare an offer based on completion of due diligence
How to conduct DD?
 Start with open mind. Identify trouble spots & ask for explanation
 Get best team of people. You may hire DD experts.
 Get help in all areas to get 360-degree view of Co.
 Talk to customers, suppliers, business partners, and employees are great resources.
 Take a risk management approach.
 Prepare comprehensive report detailing compliances & substantive risks/issues
Contents of DD Report
 Executive summary
 Introduction
 Background of Company
 Objective of DD
 Terms of reference & scope of verification
 Brief history of Company
 Assessment of Financial Liabilities
 Assessment of valuation of assets
 Assessment of Net Worth
 Assessment of Operating results

3. INVESTIGATION
Issues in Investigations
a) Whether an investigator is required to undertake 100% verification approach or selective verification approach.
b) Investigation out of disputes & conflicting claims.
c) Basis of opinion of an investor
d) Whether he can make futuristic statements
e) Whether to retain working papers or not.
f) Whether he can rely on the already audited FS
g) Whether he necessarily requires assistance of expert.
Types of Investigation
Investigation under Companies Act, 2013 Voluntary Investigation
Investigation into the affairs Investigation of Ownership
of the company u/s 210,212 & 213 u/s 216
For Incoming Partner
By Bank for Providing Loan
For Valuation of Shares
For buying Business
Investigation of Fraud

4. Investigation under Companies Act, 2013
Investigation vs Audit
Nature of Difference Investigation Audit
Objective It is inquiry in to facts Expressing opinion of Facts
Period No time fixed Quarterly, Half Yearly, Yearly
Inherent Limitations No Limitation Engagement suffers from Limitation
Evidence Conclusive Persuasive
Nature It involves detailed examination It involve sampling, Judgements
Reporting Authority initiating investigation Owners / Shareholders
Investigation in affairs of company u/s 210,212 & 213
Part-A Part-B
a) Who can initiate investigation: CG (u/s 210,213)
b) When
Suo Moto On the receipt of
(for Public Interest)
Report Intimation of SR Order of
from ROC by Company Court/NCLT
c) Who will conduct investigation - The CG may order, assign the
investigation into affairs of Company to SFIO. He shall follow the
manners and procedure as provided.
a) Who can initiate investigation: Tribunal
b) When: - on receipt of application from any person, if it is satisfied
then and is instances
Like:
-Defrauding creditors
-Company incorporated for useful purpose
-Not supplying information
c) If fraud is proven then :- Every officer of the company (or) mgmt shall
be punished for fraud (as per Sec 447)
Common point of part A and B
What powers the inspector posses:
 Investigation may extend to company, it holding, its subsidiary or any other subsidiary of such holding company
 Other body corporate having same management
 Other body corporate accustomed to act as per director of co under investigation
 Any person who was or is at any relevant time MD/ Manager/ Employee.
 Obtain information and expiation.
 Examine or both
 He shall possess allpowers of civil court.
 Apply to competent court to obtain evidence outside India.

5.  Can keep the record in custody of 180 days which can be extended further 180 days
Approach/ steps for pursuingthe investigation
 Ensure terms of engagement are not ambiguous
 Inspector should evaluate history of the company and design scope of investigation
 Plan period of investigation
 Frame, programme of other expert Examine various records interpret result.
 Consider assistance of other experts.
 Complete finding and make final report on. the conclusive evidence or reporting should be as per provision of companies Act, 2013.
Authors Notes: - Student may use above content as General steps for conducting Investigation
Investigation of ownership of a company(Section 216)
a) Who can initiate: CG
b) Why: to determine the true person/s
Who have been financial interested in success/failure of Co. Who have been able to control materially influence of Investigation
c) What is scope and extent of investigation u/s 216
 Clearly understand the scope of investigation
 Determine the areas of accounts which require investigation and extent to which enquiry in to be made
 In case of group companies, example intention of transfer securities all sales and purchases of goods from director and their associated
owners.
 Investigate breach of duty or abdication of responsibility if it has resulted into loss.
 Any negligence in the discharge of duty of a director (or) any other manager must be constructed very broadly, as they are trustees of its
property.
 Conclusion can be drawn after understanding necessary leqal assistance and by evaluation all conclusive evidence

6. Voluntary Investigation
Investigation on behalf of an Incomingpartner
Reasons: To check whether terms offered to him are reasonable to check whether his contribution would be safe and applied usefully
Areas examined:
History of Firm Position of Assets & Liabilities Profitability
Capital Employed Goodwill of Firm Areas of Specification
Partnership Deed Range of Customer Term Loans
Reason of Admission Reputation of Partners Contractual Obligation
Investigation on behalf of bank proposing to advance loanto a company
Reasons: to evaluate credit worthiness of entity approaching for loan.
Areas examined:
Purpose of Loan Project Growth Integrity of Management
Value of Securities Condensed Income Statement Past records & Growth
Government Policies Various Ratios
Valuation of Shares
Methods
Net worth Approach Yeilds Approach
Value of Shares= Total Assets – Total Liabilities Value of Shares= Present Value of FMP
No. of Shares No. of Shares
Investigation on behalf of an Individual (or) a Firm proposingto buya business

7. Reasons: To collect information which would enable the purchases to decide whether it is worthwhile to buy the business, if so for what amount:
Areas Examined:
For Proprietary Audit For Company
Reason for sale of business Other than Points mentioned beside check
Length of Property Lease, if any Capital Structure
Unexpired period of patent Class and price of shares
Managerial Staff Dividends
Customer Base Mortgages, if any
Goodwill
Investigation of Frauds:-
Fraud is intentional act, executed to gain unjust/illegal advantage. It includes misappropriation of money (or) goods, manipulation of accounts, etc
(i) Frauds at different Level
Fraud for Personal Gain Corporate Frauds / Irregulation Fraud at Operational Level
Bribery Advance Billing Tampering of cheques/ drafts/
online payment/ Receipts
Shell/Dummy Company Schemes
Money Laundering Activities Off Book Frauds
Cash Misappropriation
Teeming and lading
Fraudulent disbursement
Expense disbursement Schemes
Payroll Fraud
Commission Schemes
(ii) Verification of Fraud in
Fraud for Personal Gain Corporate Frauds / Irregulation Fraud at Operational Level
Different sources of Income Internal Controls Goods inwards Book
Completeness of Income accounted Acknowledgment Credit for goods received
Negligible source of income Bearer Cheques Rebates
Copies of Receipts Petty Cash Related Parties
Cash Discounts Unusual Payments Balance Confirmation
Serially numbered Dummy Workmen
Cancelled Receipts Alternations in payments

8. Cash Deposited & Withdrawal Related Parties
Cash Sales
(iii) Areas to be examined if in spite of increase in sales turnover there is decline in profits
Unfavourable sales mix Competitive Price
Negative impact of Financial Leverage Additions to Fixed Assets (depreciation)
Cost included in Sales Lost Price Relationship
High Admin Cost
(iv) Factors considered in assessing the future maintainable turnover
Trend Marketability
Political / Economic Condition Competition
(v)