Due diligence is a key element of any merger & acquisition (M&A) transaction.
Not only does comprehensive due diligence help investors better understand the worth of the target company, but it also generates vital information that can significantly increase the investor’s leverage during negotiations.
A number of factors impact the exercise of due diligence.
Every business has its own peculiar features. In carrying out due diligence it is vital to keep in mind the specific features and peculiarities of the business in question.
For example, one of the most important assets of a business in the telecommunications sector is its licence to operate.
As a result, any due diligence process should focus primarily on the validity and transferability of such licence to another party.
The type of assets that should be examined and analyzed can be different from industry to industy.
Whereas the businesses in the telecoms sector are dependent on their licences, the most important assets of any business in software development or manufacturing and distribution of high end pharmaceuticals are the intellectual property rights it enjoys over its various products.
Any due diligence exercise carried out in relation to such companies must focus on their intellectual property assets and any potential legal threat to them.
For companies engaged in the manufacture of chemicals or hazardous substances the issue of compliance with environmental regulations is of much more significance than it would be for a company involved in designing software or animation.
So, one cannot overemphasize the significance of carrying out due diligence geared towards a careful analysis of the specific needs and characteristics of the business in which the target company is engaged.
Liabilities and litigation
The due diligence exercise must carefully analyze the nature and effect of both existing and potential litigation against the company targetted for acquisition.
Here again, the type of business directly impacts the amount of potential litigation a company may be subject to.
Environmental litigation, tax related litigation, labour and consumer disputes could be significant enough to bring a company to its knees.
Additionally, the issue of regulatory compliance is important.
Non-compliance might lead government authorities to launch strict action against the target company and this could lead to the temporary or permanent suspension of the target company’s business and activities.
All outstanding warranties, indemnities and obligations owed by the company along with details of any intra-corporate transactions should be properly identified.
This is crucial.
Negligence in this regard could create unforeseen liabilities and financial hardship.
Another issue that needs to be analyzed relates to any power or authority that may have been granted by the company to any entity or individual to represent and bind the company in any transaction or any other financial commitment.
It is important to ensure that no such authorizations have been used in a way that might restrict the company’s business in the future.
Any issues that cannot be verified during the due diligence process must make its way to a “Conditions Subsequent” clause in the contractual documents.
Depositing a part of the purchase price in an escrow account and releasing it only on the fulfilment of the obligations mentioned in the Conditions Subsequent clause is one effective safeguard often used in M&A transactions.
Cross-border M&A deals pose unique challenges and legal complexities.
An international investor contemplating an acquisition in India must take into account foreign exchange restrictions that may affect the investor’s ability to repatriate profits.
Additionally, pricing guidelines could drastically reduce the amount of money a foreign investor may receive on the sale of shares held in Indian companies.
Ultimately, the success of any M&A transaction depends, to a large extent, on the quality of the due diligence process undertaken before the transaction.
Baljit Singh Kalha is a partner at Titus & Co. He may be contacted at: email@example.com.
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