Due Diligence

APURVA AGARWAL

PartnerUNIVERSAL LEGAL

The Institute of the Company Secretaries of India

February 15, 2008

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Meaning of Due Diligence

• There is no legal definition of the term "due diligence".

• Simply put it is a detailed investigation of the affairs of a company.

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Meaning of Due Diligence

It is the process of carrying out an investigative analysis of the financial, legal and operating activities of an entity in connection with a proposed transaction that would result in a significant change in the ownership or the capital structure of the entity.

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Aim of the Due Diligence Process

Identify problems within the business, particularly any issues which may give rise to unexpected liabilities in the future.

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Ingredients of a successful Due Diligence

• Must be unbiased

• Should be carried out by independent professionals.

• Requires the management’s co-operation

• Done with a positive attitude

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Purpose of Due Diligence

1. Assess the reasonableness of historical and projected earnings and cash flows;

2. Identify key vulnerabilities, risks and opportunities;

3. Understanding the company and its market

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Purpose of Due Diligence

4. Setting in motion planning for post-IPO operations

5. Highlight changes required in the company’s tax, legal, corporate or shareholding structures

6. Check whether the Company has complied with all the laws

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Need for Due Diligence in IPO’s

• Going public increases the number of shareholders.

• Board performance subject to closer scrutiny.

• Institutional investors look for increases in share prices,achievement of profit targets and dividend pay-outs.

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Need for Due Diligence in IPO’s

• Investors require assurance of a system of strategic planning and budgeting,financial reporting and management information

• The SEBI disclosure requirements are met through the due diligence process

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Key Areas of Focus

1. Financial statements – to ensure their accuracy

2. Assets - confirm their value, condition existence and legal title

3. Employees – identification and evaluation of the key movers

4. Sales strategy – analyzing the policies and procedures in place

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Key Areas of Focus

5. Marketing – what is driving the business and is it effective?

6. Industry in which the company operates – understand trends and new technologies

7. Competition – identify the threats

8. Systems – how efficient are they? Are upgrades required?

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Key Areas of Focus

9. Legal and corporate and tax issues – is the shareholding structure robust? Are there any tax issues which need to be resolved?

10. Contracts and leases – identify what the risks and obligations are;

11. Suppliers – are they expected to remain around?

12. Intellectual Property - protected and to what extent?

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Legal Issues

1. Licenses and Permissions

2. Litigation

3. Real Estate and Moveable Property

4. Company Law

5. Employees, Consultants, Labour Relations

6. Environmental Permissions

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Gap Analysis

The due diligence helps identify areas where the company exhibits weaknesses

Eg: It may highlight deficiencies in the company’s management structure or an inefficient tax structure.

Therefore pre-IPO due diligence process will result in a gap analysis between the present status of the company and the company that should be floated.

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Filling in the Gaps

Gaps identified assist the directors in:

1. divesting of non-core, non-profitable activities.

2. critical analysis of the control, accounting and reporting systems

3. critical appraisal of key personnel.

4. identify the value drivers of the company

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Consequences of Misrepresentation in Offer

Documents

• Civil liability under S. 62 of the Companies Act, 1956 for misstatements.

• Liability is in the form of compensation to any person who has sustained loss or damage due to such misstatement.

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Persons liable under S. 62

• Every director holding office

• Every person named in the offer document as a director or a proposed director

• Every promoter of the Company

• Every other person who has authorized the issue of the prospectus

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Criminal Liability

• S.63 of the Companies Act, 1956 provides for punishment in the form of imprisonment and fine upto Rs. 50, 000/- for any untrue statement.

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Persons Liable under S. 63

Any person who has authorized the issue of the prospectus except:

• An expert who has given his consent to have his statement recorded in the prospectus

• Auditor, legal advisor, attorney, solicitor, banker or broker who has given his consent to include his name in the offer document in any capacity.

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ANY QUESTIONS

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THANK YOU

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Universal Legal Advocates

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77/79, Maharshi Karve Road,

Mumbai-400002

Ph: + 91 22 22034293-95 Fax: + 91 22 22039845

Email: apurva@universallegal.firm.in