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Due Diligence for Merger & Acquisition, Corporate Restructuring and Takeover

Delivered a talk on Due Diligence for Merger, Acquisition & Take Over at ASSOCHAM's 3rd National Seminar at Park Plaza, Ashoka Road, New Delhi.

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Due Diligence for Merger & Acquisition, Corporate Restructuring and Takeover

  1. 1. Due Diligence for Mergers & Acquisitions 11/02/2015
  2. 2. - AGENDA  Why Due Diligence is important for M&A;  Objective of Due Diligence;  Types of Due Diligence Overviews;  When Due Diligence becomes Relevant;  Key Focus Area in Due Diligence;  Due Diligence Process;  Common Due Diligence Issues in India;  Case Study;  Summary;  Conclusion . DUE DILIGENCE : LEARN FROM THE PAST, BUT LOOK TOWARDS THE FUTURE 2
  4. 4.  To investigate into the Affairs of Business as a prudent business person  To confirm all material facts related to the Business  To assess the Risks and Opportunities of a proposed transaction.  To reduce the Risk of post-transaction unpleasant surprises  To confirm that the business is what it appears. Why Due Diligence is Important for M&A….?? 4
  5. 5.  To Create a Trust between two Unrelated Parties  To identify potential deal killers defects in the target and avoid a bad business transaction.  To gain information that will be useful for  Valuing Assets  Representations & Warranties for Indemnification  Negotiating Price Concessions Why Due Diligence is Important for M&A….Cont… 5
  6. 6.  To verify that the transaction complies with investment or acquisition criteria.  To Investigate & Evaluate a Business Opportunity  It Involves an analysis carried out before acquiring a controlling interest in a company. DUE DILIGENCE IS NOT THE JUDGEMENT MAKING IT IS JUST BRING OUT ALL FACT TO FORE Why Due Diligence is Important for M&A….Cont… 6
  8. 8. Objective of Due Diligence To determine compliance with relevant laws and disclose any regulatory restrictions on the proposed transaction To evaluate the condition of the physical plant and equipment; as well as other tangible and intangible Assets To ascertain the appropriate purchase price & and the method of payment. To determine details that may be relevant to the drafting of the acquisition agreement, To discover liabilities or risks that may be deal-breakers To analyze any potential antitrust issues that may prohibit the proposed M&A To evaluate the legal and financial risks of the transaction 8
  10. 10. Types of Due Diligence Overviews Cont.. Operational Due Diligence Operational Due Diligence aims at the assessment of the functional operation of the Target Company. BUSINESS DUE DILIGENCE Strategic Due Diligence Technical Due Diligence Strategic Due Diligence tests the strategic rationale behind a proposed transaction and analyses whether the Deal is commercially viable, whether the targeted value would be realized Intellectual Property Due Diligence – Review & diligence of Intangible Assets like Patent, Copyright, Design, Trademark , Brands etc. getting greater importance. Technology Due Diligence – Technology Due Diligence considers aspects such as current level of technology, Company’s existing technology, further investment required etc. 10
  11. 11. HR Due Diligence BUSINESS DUE DILIGENCE HR Due Diligence aims at People or related issues. Key managers and scarce talent leave unexpectedly. Environmental Due Diligence Environmental Due Diligence analyses environmental risks and liabilities associated with an organization . Information Security Due Diligence It is often undertaken during the information technology procurement to ensure that risk are uncovered. Types of Due Diligence Overviews Cont.. 11
  12. 12. Legal Due Diligence A Legal Due Diligence covers the Legal Aspects of Business Transaction liabilities of the Target Company, potential legal pitfalls and other related issues. Legal Due Diligence covers intra-corporate and intercorporate transactions. LEGAL DUE DILIGENCE Types of Due Diligence Overviews Cont.. 12
  13. 13. Financial Due Diligence provides peace of minds to the both Corporate and Financial buyers, by analyzing and validating all the financial, commercial, operational and strategic assumption being made. Financial Due Diligence includes review of accounting policies , review of internal audit procedure, quality and sustainability of earning and cash flow, condition and value of Assets, potential liabilities and tax implication on Deal Structure. FINANCIAL DUE DILIGENCE Financial Due Diligence Types of Due Diligence Overviews Cont.. 13
  15. 15.  Deal Strategy Validation  Value Driver Identification  Identifying black holes  Valuation Identifying Deals Evaluating Deals Executing Deals Making Deals Successful Harvesting Deals • Structuring and Negotiating issues • Matters to be included in Shareholders / other agreement • Representation and warranties / indemnities involved • Design tax efficient structures for acquisitions and disposals • Planning exit strategies When does Due Diligence become relevant? 15
  17. 17.  Focuses on historical results to form a view of future and confirm there are no “black holes”;  Key outputs:  Quality of earnings  Quality of net assets and working capital  Confirms or provides business model assumptions  Identifies risks and possible mitigators, via representations & warranties, purchase price adjustments and completion reviews  Generates negotiation points to support your offer and refute counter arguments; Definitions / Business Conduct Issues / Indemnifications Financial Due Diligence – Cornerstone of Every Deal GOAL - Analyze and validate financial, commercial, operational and strategic assumptions underpinning a Deal; 17
  18. 18. Financial Due Diligence typically focuses on…. Review of Internal Control and MIS systems Group company transactions and dependence – this would highlight Separation / Stand Alone Issues. Trading Results – segment wise and identification of Extraordinary/ exceptional items, if any. Gross Margins and EBITDA analysis. Management & Employees and their Relationship Specific regulation for business / industry  Impact of Discontinued operations. 18
  19. 19.  Complex tax and regulatory regime in most Asian countries;  Different legal structures and industry segments have different tax risk profiles;  Key outputs:  Identifies tax risks as well as compliance status of Target  Advise on how identified tax exposures can be mitigated  Provides optimal financial and tax structure for the proposed deal Direct and Indirect Tax Due Diligence GOAL - Evaluate potential tax implications of the transaction and tax position of the Target; 19
  20. 20. Tax Due Diligence Typically Focuses On.. Status of Direct and Indirect tax assessments. Review of audits carried out by the respective tax authorities Review of the claims made by the tax authorities and the responses made. 20
  21. 21.  Typically involves a combination of desk research, interviews with target management team, key trading partners and industry experts;  Key outputs:  Issues in respect of achievability of business plan projections  Target’s positioning and competitiveness  Target specific market and industry related issues  Identifies strategic value creating opportunities  Highlights Exit risks and opportunities Market Due Diligence GOAL - Assist in understanding the condition and prospects of the market a Company wishes to enter in; 21
  22. 22.  Covers full scope of business operations from supply chain and logistics to manufacturing and commercial activities;  Ensures that sufficient work is done on some of the operational assumptions that are key to the success of a deal;  Key outputs:  Assess operational effectiveness  Identify and quantify opportunities for operational improvement and develop action plans to deliver against these opportunities  Assess existing management structure and provide insight on personnel related issues Operational Due Diligence GOAL - Gaining a coherent overview of a Target’s operations 22
  23. 23.  Particularly important for M&A in the IT services sector;  Key outputs:  Assess existing IT infrastructure and future needs  Provides inputs for planning integration of systems and applications  Highlight key business process issues, such as in purchases & payables cycle, revenues & receivables cycle  Assess security & controls to ensure data integrity, availability and confidentiality IT Due Diligence GOAL - Evaluation of IT security & controls and business process issues 23
  24. 24.  Typically covers pension and employee liability valuation, payroll costs validation, employment termination costs, compensation and benefit alignment costs  Key outputs:  Assess existing levels of employee proficiency against industry standards  Highlight redundancy issues  Assess potential for redeployment of staff  Analyses of industrial relations  Assess employee compensation, including retirement benefits HR Due Diligence GOAL - Qualitative evaluation of existing staff including HR policies 24
  25. 25. Buy Side Diligence (For ascertain what buyer are buying ) Sell Side Diligence (Issues on which buyers can negotiate) v/s Types of Due Diligence Reviews – Purpose 25
  26. 26.  Financial analysis to support opinions and conclusions.  Identification of hidden value in the target.  Highlighting post-acquisition / integration / separation issues.  Using expert resources in the target country to identify local risks and issues.  Identifying areas that may impact the exit strategy of the equity provider.  Analysing the sustainability of earnings and cash flows. Buy side Due Diligence 26
  27. 27.  Assists the vendor by providing an upfront independent review.  Highlights sale and purchase agreement issues early that may become negotiating points or areas for warranties/indemnities.  Ensures a level playing field by providing all potential purchasers with objective information.  Reduces the level of due diligence procedures that potential purchasers need to perform.  Expedites the deal timetable by avoiding lengthy negotiations and disruption to the vendor.  Reduces the risk of last minute value erosion and avoid lengthy re-negotiations. Sell side Due Diligence 27
  28. 28.  Full Access Full access to the target management, staff, accounting, financial and legal data.  Limited Access Limited access to the target management, staff, accounting, financial and legal data.  No Access Strictly controlled environment, typically based on publicly available data.  Carve Out Strictly limited to the part of business proposed to be sold. Types of Due Diligence Reviews – Access Levels 28
  29. 29. Due Diligence Financial and Taxation Operational & Technical Human Resource Legal and Contingent Obligation What should the methodology be to Generate following key outputs Attain complete understanding of the business and the assets Identify potential risks associated with the transaction & the mitigating factors Identify key deal issues and deal breakers and determine possible reductions in the purchase price Assess integration and other post deal matters 29
  31. 31. Consider Preliminary Structure Visit Data roomReview Background Material Review Audit Work Paper Assist with letter of Intent Visit Target Company and Interview Management Develop workmen and info Request List Review financial model of Target Company Preparation of Report Finalize Structure Support Integration Plan Read and Comment on Sale Agreement Pre-Fieldwork Fieldwork Post-Fieldwork Typical Diligence Process 31
  32. 32. Cultural AspectsTaxation Aspects Marketing Information Litigation Aspects Basic Information Financial Data Environmental Impact Internal Control System IPR Details Important Business Agreement Documents To be checked in Due Diligence Processes 32
  34. 34. Common Diligence Issues in India Charge backs, rebates and returns Inappropriate revenue recognition Inadequate reserves and reversal of reserves including inventory Improper cutoff and rollover impact; Financial & Restrictive Covenants in agreements / legal documents Improper cutoff and rollover impact; Unsophisticated financial reporting system Issues for representation and warranties from the buyer Related party transactions – stand alone issues Implications of Regulations, Taxes & Duties – based on deal structure 34
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  36. 36. Some Practical cases  When Dai-Ichi bank of Japan merged with Nippon Kangyo to form the then biggest bank in the world called Dai-Ichi Kangyo, the two company executives found even the definition of the word, ‘loan’ differed between the banks!  They had to put out a 200-word glossary explaining the meaning of various banking terms before they could even start! 36
  37. 37. Some Practical cases Cont…  Dai Ichi Sankyo paid $4.6 B for 63% of Ranbaxy A YEAR LATER IT WROTE DOWN the value of the acquisition by $3.6 B.  REASON: They did not know the depth and extent of Ranbaxy’s woes and full details of the Food and Drug Administration (FDA) investigation into Ranbaxy. In fact in 2009 FDA had shut down reviews of all pending or future drug applications from Ranbaxy’s Ponta Sahib plant. The first-to-file atorvastatin (Generic for Lipitor world’s largest selling drug) was the greatest attraction for Dai Ichi and that was fraught with many problems.  DAI ICHI HAVE MADE INADQUEATE DUE DILIGENCE STAGE AND RESULT THEY EARN HUGE LOSS. DAI ICHI AND RANBAXY DEAL 37
  38. 38. Some Practical cases Cont… HCL AND AXON DEAL  Infosys and HCL bid for Axon in Sep 08, HCL countered Infosys bid of 600 pence with an aggressive offer of 650 pence;  INFOSYS WITHDREW AND HCL TOOK IT OVER NOTE: HCL did make the acquisition work by doing all the right things –main one –by eating the ego! They reverse merged HCL teams into AXON as AXON was a high performance team and they were better than HCL –thus HCL Axon was born. HCL DURING HR DUE DILIGENCE UNDERSTOOD THE FACTS THAT AXON TEAM HAS HUGE POTENTIAL AND DEAL CREATE SYNERGEY FOR HCL-AXON. 38
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  40. 40.  Identification of “deal breakers”.  Adjustment to “pre-diligence” valuation.  Negotiation support.  Conditions in Share Purchase Agreement (SPA).  Representations and Warranties.  Inputs for post deal action points. In Summary…Result of the Due Diligence 40
  41. 41. Quality of Assets Quality of Earnings & Cash Flows Potential Liabilities & Commitments Separation / Structuring / Integration Issues Tax and Other Regulatory Issues Other stand alone issues Co-ordination with other advisors and issues identified by them Industry and market issues In Summary……Due Diligence Focuses On. 41
  42. 42. PARTICULARS DUE DILIGENCE AUDIT Scope Includes not only Financial Analysis but also business plan, sustainability of business plan, future aspects, corporate and management structure and legal issues. Limited To Financial Analysis Data Covers future growth prospects in addition to historical data Based on Historical data Mandatory Mandatory based on Transaction Mandatory Assurance Negative assurance i.e. identification of Risks if any Positive assurance i.e. True and fairness of the financial statement Type It is required for future decision Post mortem analysis Nature Varies according to the nature of Transactions Always uniform Repetitiveness Occasional event Recurring event Due Diligence V/S Audit 42
  43. 43. CONCLUSION 43
  44. 44. The goal of DUE DILIGENCE should be DEAL MAKING not KILLING… 44
  45. 45. Corporate Professionals Capital Private Limited D-28, South Extension –I, New Delhi-110 049 Ph: +91.11.40622200; Fax: +91.11.40622201; E: Pavan Kumar Vijay Managing Director 45