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DUE DILIGENCE
HEART OF A PRIVATE EQUITY TRANSACTION
DUE DILIGENCE: WHAT WHY WHO WHEN
WHAT IS DUE DILIGENCE?
• Black’s Law Dictionary defines Due Diligence as a measure ofprudence or activity to be expected from, and ordinarily exercisedby a reasonable or prudent man under the particularcircumstances, not measured by an absolute standard butdependent of the relevant facts of a particular case.
• Due diligence is used to investigate and evaluate a businessopportunity. It spans investigation into all relevant aspects of thepast, present, and predictable future of the business of a targetcompany.
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WHY DUE DILIGENCE IS NECESSARY?
• To confirm that the business is what it appears to be;
• Identify potential "deal killer" defects in the target and avoid abad business transaction;
• Gain information that will be useful for valuing assets, definingrepresentations and warranties, and/or negotiating priceconcessions; and
• Verification that the transaction complies with investment oracquisition criteria.
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WHO CONDUCTS DUE DILIGENCE?
• Lead and co‐investors, corporate development staff, attorneys,accountants, investment bankers, and other professionalsinvolved in a transaction may have a need or an obligation toconduct independent due diligence.
WHEN IS DUE DILIGENCE CONDUCTED?
• Detailed due diligence is typically conducted after the partiesinvolved in a proposed transaction have agreed in principle thata deal should be pursued and after a preliminary understandinghas been reached, but prior to the signing of a binding contract.
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Due‐ Diligence Process
Understand the checklist
Getting the data room ready
Report the findings/ take corrective actions
Incorporate findings in the transaction documents
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Due DiligenceHeart of the PE Transaction
Pre deal Deal Post deal 6
AVOIDABLE EVIL vs. NECESSARY EVIL
MYTHNeed for due diligence canbe eliminated by Warrantiesor Indemnity Protection
Only investors need toconduct due diligence
Due diligence is all aboutcompliance and legalliabilities review
FACTDUE DILIGENCE IS A TOOLTO
• Evaluate the valuation of the Target Company
• Structure the deal• Effectively manage Issues and Risks
• Assist in creating a Road Map for future
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EFFECTIVE DUE DILIGENCE
Clearly establishes objectives
Effectively provides for issues and risk management
Suggests post deal improvements
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India Vs. West
Fact finding mission Vs Risk allocation exercise
No set pattern or ‘formula’
No implied representations and warranties
Difficulty/Delays in enforcing warranties and indemnities
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CRITICAL AREAS TO LOOK FOR IN DUE DILIGENCE
Capitalisation of the Company
Related Party Transactions
Business Contracts
• Vendor Contracts
• Customer Contracts
• OEM Contracts
Ownership of IPR (if IPR is critical to the business of the Company)
• Patents, Trademarks, Copyrights
Approvals and Licenses
Loan Agreements/ Line of Credit10
AT THE CORE…
DUEDILIGENCE
ISSUES
RISK
LIABILITY
CONDITIONS PRECEDENT
WARRANTIES
INDEMNITIES &PRICE RETENTION
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EXAMPLE OF CONDITIONS PRECEDENT
• FINDINGS OF DUE DILIGENCE
The Company has entered into aloan agreement with a bankwhich requires the Company totake prior approval from the bankregarding any change in controland management of thecompany.
The Company does not haveenough authorised share capitalto issue shares/ debentures tothe Investor.
• CONDITIONS PRECEDENT
There will be a conditionprecedent as per which theCompany will be required to takeapproval from the bank for theproposed investment.
There will be conditionprecedent requiring the Companyto increase its authorised sharecapital before the investment.
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EXAMPLE OF WARRANTY• FINDINGS OF DUE
DILIGENCEThe application for registration oftrademark of the Company ispending.
The Company represents that itdoes not have any pendinglitigation however therepresentation is not absolute asit is not possible to find out if anylitigation is pending in the trialcourts.
• WARRANTY
A warranty shall be taken fromthe Company that it owns all theintellectual property belonging tothe Company and it does notinfringe the rights of any thirdparty.
A warranty shall be taken fromthe Company regarding absenceof any litigation and indemnity tothe Investor in case any loss isincurred on account of anylitigation.
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EXAMPLE OF RELATED PARTY TRANSACTIONS
• FINDINGS OF DUE DILIGENCEDaughter of one of the directorsis employed as executiveassistant and she is drawing muchmore than her prescribe salary byway of additional perks.
The company has entered into arent agreement for one of itswarehouse with the relative ofthe director.
• REMEDIAL ACTION
There will be condition precedentrequiring the Company toterminate the employmentagreement of the related party.
It will have to be verified that therent for the warehouse is on armslength basis.
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ROLE OF LAWYERS AND COMPANY SECRETARIES
PRE DEAL• Regulators for the transaction• Facilitate transaction – Advice on Structuring• Risk evaluators and managers• Sensitize parties to cultural deal approach issues (Cross
border transactions)POST DEAL
• Monitor conditions subsequent• Do necessary filings with the Reserve Bank of India and
other regulatory authorities
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LIMITING FACTORS
Dependent on information shared by the Target Company
Pressure to conclude transactions
Competition in the PE world
Time and Cost
Transactions based on good faith
Viewed as an obtrusive and time taking exercise16
QUESTIONS
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