Due Diligence, A Vital Element in Mergers and Acquisitions

Raghunath.T, Director


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    HP’s $11.1 billion acquisition of Autonomy was one of the biggest tech acquisitions in history. What actually stole the headlines is not the news of acquisition or the money involved, but HP’s decision a year later to write down $9 billion of its $11.1 billion acquisition. One might wonder the reason behind such a crucial decision.

    Well, as alarming as it may sound, HP alleged that Autonomy forged its financial statements. The company accused “some former members of Autonomy’s management team” of using “accounting improprieties, misrepresentations and disclosure failures to inflate the underlying financial metrics of the company.”

    What went wrong and where; a question that pondered every individual in the investment and technology arena. Inadequate due diligence is the reason behind such a crisis. Due diligence is the key to a successful acquisition, that gives you complete information about the company you plan to acquire.

    Due diligence is of utmost importance in any Mergers & Acquisition process, regardless of the size or structure of the company. A mere glance at the financial sheets or company records, won’t do justice to the due diligence process. Developing and implementing a vigorous due diligence process involves wide-ranging activities.

    The case of HP is not a rare one; there are numerous other companies that have become the scapegoats of incomplete or wrong due diligence process. A thorough examination is all that it takes to avoid any nasty surprise once you have signed the agreement.

    While majority of the companies approach due diligence teams, in search for ‘red flags’, the process shouldn’t be limited to the same. Your checklist must include a detailed analysis of the financial, cultural, legal, and administrative background of the target company. This will help the management in predicting the success or failure of an acquisition before they proceed further.

    Types of Due Diligence

    Financial DD
    Focuses on verifying the financial information provided and to assess the underlying performance of the business in terms of earnings, assets, liabilities, cash flow, debt, management etc.

    Commercial DD
    Aims at understanding the market through review of market conditions, sector specific legislation, competitor analysis, product or service assessment or any other commercial aspects the user wishes to investigate.

    Tax DD
    Assessment of tax impact arising from ‘change in control’, assessment of historical tax exposures, identifying tax saving opportunities, assessment of current tax position, assessment of various modes of tax neutral deal structuring

    Human Resources DD
    Focuses on the impact of human capital by identifying the qualifications, technical ability and working initiative of the target firm’s senior management personnel and key staff.

    Operational DD
    Consideration of non-financial (operational) matters of an investment decision, which may include assessment of systems and processes, review of the incumbent management team, staffing levels and other HR activities, or insurance arrangements and risk assessment.

    Legal DD
    Investigation of any legal risk associated with the rights and obligations of the investment decision. Issues may typically involve property ownership, intellectual property and employment disputes.

    Environmental DD
    Typically concerns compliance issues with environmental legislation, but recent trends for ethical and responsible business dealings have lead to a sharper focus on ‘green’ issues.

    Administrative DD
    Involves verifying admin-related items such as facilities, occupancy rate, number of workstations, etc. The idea is to verify the various facilities owned or occupied and determine whether all operational costs are captured in the financials.

    Asset DD
    Includes a detailed schedule of fixed assets and their locations, all lease agreements for equipment, a schedule of sales and purchases of major capital equipment during the last three to five years, real estate deeds, mortgages, title policies, and use permits.

    Intellectual Property DD
    Schedule of patents and patent applications, schedule of copyrights, trademarks and brand names, pending patents clearance documents, any pending claims case by or against the company in regard to violation of intellectual property.

    Customer DD
    Examination and analysis of the top customers, service agreements and corresponding insurance coverage, current credit policies, customer satisfaction score and related reports from the past three years.

    An experienced due diligence team will help you recognize possible risks and potential opportunities and also ensures that not a single factor has been overlooked.

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