Due Diligence : Meaning and its importance

Before entering into a business transaction, one looks out for n number of factors affecting the trade. Consideration involved, growth prospects in the future, taxation, law compliances, and many other points are considered. But is it enough to forethought about these factors only, or are there other points too, to give a thought about? 
 
While trying to know what growth one can expect out of a transaction in the future, we often overlook the background of the business. The past of any organisation influences its future also. Suppose company A wants to take over company B. Company A sees the transaction as a good one by only looking at the future growth potential, but it misses taking note of its past litigations. If A makes the deal and learns about the legal issues later, it will also impact its future as they were unaware of them.Now, one can think of how significant due diligence is for an impending transaction.
 
Due diligence is a type of investigation into the company's affairs, revealing information about the organisation that is not readily available to outsiders but can only be found out if investigated and looked into intensely. In this text, we have covered almost everything about this due diligence activity, which can help decide you better, whether to make or break the deal. 
 
Due diligence is a background check to examine and evaluate all the possible growth aspects and risks involved in and after the transaction. It is done for the safety of both the buyer and seller's interests. 

Some of the different areas where due diligence is needed before entering into a deal or transaction are 
 
*Takeover

*Merger and acquisition

*Public issue of securities

*Due diligence of banks

Due diligence stages-

This process of due diligence can be divided into three phases; pre-diligence, diligence and post diligence. All these phases are essential to the whole operation. 

Pre diligence:

 This is the initial stage in which the documents are collected for examination later. This step is all about planning. A checklist is prepared, and following that, all the documents are asked for. These documents are then taken into this physical or virtual location called a data room. 

Before providing the documents and information, it is good to sign a letter of intent (LOI) and a non-disclosure agreement (NDA) between the parties.
 
* Letter of intent ensures that the parties intend to enter into a business transaction. It does not necessarily bind the parties to enter into the transaction, as the parties can still withdraw their proposal on finding anything that seems to them as a deal-breaker. 
 
* NDA is the most important agreement when it comes to providing confidential business information to the other party. By entering into this agreement, the buyer becomes legally bound to keep the data secured and confidential. 
 
The data collection process is a tedious job. To manage this task along with the primary operations of the company is challenging. To avoid this hardship, one can outsource this work by hiring an external agency having experience of proficiently handling such tasks. This process is also time-bound, making it even more important to use it to the full advantage in a limited time frame.

The documents should be examined and read carefully. This examination depends on the transaction. If the deal is crucial and holds great significance to the party, the investigation should be thorough, covering every piece of information provided by the other party. 
 
When collecting data, it is important to categorise and plan what is needed and what is not. The transaction itself is a hectic task; hence, one should avoid unnecessary information and only examine selective material data, making the job less time-consuming. Below given are the points which are common in nature and looked into while carrying out diligence process for any transaction-
 
* The charter documents of the organization
 
* Loan and charges created on any property of the organisation 
 
* Financial statements and other related information
 
* History of the organisation, its employees, business failures, if any
 
* Existing contracts and agreements 
 
* Compliance with the laws or any litigation, past or present
 
* Information about partners, suppliers and customers

Diligence

: A due diligence report is prepared and submitted to the management of the party to which it concerns. This report should be prepared carefully, as all the output from this process depends highly on this report. One should try to make the report concise and direct.
 
It should include-
 
* the purpose behind this diligence process
 
* documents used in the process
 
* complete analysis, end conclusion and other points to be considered
 
This report should mainly focus on-
 
* The commercial viability of the transaction or project
 
* Future growth prospects if the transaction is entered into
 
* The level of synergy expected out of the proposed transaction
 
* Technology being used in the organisation

* Possible risks and liabilities
 
* Litigation existing or expected
 
* Employees of the organisation, their potential and reluctance to change, if any

Post diligence:

After examining the documents and reporting, the buyer decides whether he wants to break or make the deal based on the findings stated in the report. The scope for negotiation is known, and this is the part where the buyer holds power to bargain and ask for warranties if needed.
 
This process has its own limitations, which one should keep in mind all the time so that the chances of errors are minimised.
 
* Due diligence is performed to reveal the true picture and state of the business. But the findings of this process depend majorly on the information provided by the seller. There are great chances that the seller may try to hide its business's negatives or show reluctance to assist. So, it becomes the job of the professional carrying out the task to divulge as much as possible.
 
* This being a tiresome task, extra patience and a calm attitude are expected from both parties.
 
* Poor understanding of the objectives and motives may not get the best results. 
 
* This process is costly and involves intensive mental labour. So, efforts should be made to wrap the work at the earliest.  
 
All things considered; due diligence is like a SWOT analysis. It is a tedious job, but in today's world, where it is so easy to conceal and misrepresent facts, it becomes crucial to become fully informed about the organisation before entering into the transaction and avoid losing later.