Importance of Due Diligence in M&A transactions
Due diligence is an investigation, audit, or review performed to confirm facts or details of a matter under consideration. Due diligence involves examining a company's numbers, comparing the numbers over time, and benchmarking them against competitors. Due diligence often refers to the in-depth research and study being done before signing an agreement or a business with a party. Assessing the key issues/risks faced by the business.
Who needs a due diligence check?
Due diligence is required for
Due diligence check is needed for all companies and organisations if they engage in company merger or acquire any stakes, property, real estate, investments, investors or insurance transactions in other companies, or if they work with business partners, especially in an international context.
It is also a good idea to assess your target company, prospects before signing a sales contract to avoid issues in future.
Why do companies and organisations need a due diligence check?
Due diligence risk and compliance check tool helps companies protect their interests, for example in the context of M&A activities, to safeguard the value chain or comply with sanctions and with legislation on the prevention of money laundering, bribery and corruption. Due diligence and continuous market monitoring help companies in different ways:
Let us see the practical case study scenario on CEO being removed and funding has been dropped because of fraud identified during the Due diligence report.
In case of Housing.com in 2015, the company's investors commissioned a due diligence report which uncovered several irregularities, including fraud committed by Yadav. The report alleged that Yadav had made false claims about Housing.com's business and financial performance and had also violated corporate governance norms. Following the report, Housing.com's board decided to remove Yadav as CEO, and his resignation was accepted in April 2015. The report also led to several investors withdrawing their funding from the company, which faced financial difficulties in the following months.
When is Due Diligence required?
Who helps the companies with the check?
Because of the complexity of the requirements, it is advisable to call on trained staff (in house employees, risk and compliance analyst) or external advisors (tax consultants, auditors, lawyers, technical experts, management consultants) to perform a due diligence check. The due diligence cost may be tax-deductible. For corporation tax purposes, the due diligence costs can be deductive if they are:
- Charged to profit and loss account and
- Are for good use of the trader or business.
As a general rule, the greater the potential risk, the greater the resources that should be invested in a check.
How due diligence report helps for companies and Investors
This report captures the findings of the diligence process. In turn, it allows investors to have a clearer understanding of the investigated firm.
Let us see how a report has effected in its increase in valuation of the company through below case study-
Acme Corporation, US based company a leading provider of cloud-based software solutions, has seen a significant increase in its valuation following a positive due diligence report conducted by a leading private equity firm. The private equity firm, which was considering an investment in Acme Corporation, hired a third-party firm to conduct due diligence on the company. The due diligence report revealed that Acme Corporation's software solutions had a strong track record of customer satisfaction and were well-positioned to capitalize on the growing demand for cloud-based software. The report also highlighted Acme Corporation's experienced management team and strong financial performance. Based on the positive due diligence report, the private equity firm decided to invest $100 million in Acme Corporation in exchange for a 25% ownership stake. This investment values Acme Corporation at $400 million, up from its previous valuation of $250 million. The increased valuation reflects the private equity firm's confidence in Acme Corporation's ability to continue to grow and expand its market share. "The due diligence report has given the great confidence in Acme Corporation's ability to continue to grow and innovate in the cloud-based software industry. This investment will allow them to accelerate growth plans and continue to provide their customers with innovative, high-quality software solutions.
So we can conclude that Due diligence is a or effort to collect and analyse information before making a decision. It is often used by the investors to assess the risk, companies who are considering acquiring another firm.
Prepared by : Pavan Kumar S