Due Diligence
M&A
Prof.Sonali
3/28/2012
Operational Due Diligence
Operational Due Diligence (ODD) enhances decision
making and reduces risk through a better understanding of how the business works. It provides a more robust perspective on what a client can expect from the target's future operational performance. One measure the effectiveness and efficiency of the company's business units against the management's own performance targets, as well as industry benchmarks. One also have to identify the developments within the industry that can impact the operational efficiencies of the target, and wherever possible, develop mitigation plans.
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Operational Due diligence varies from target to target .It involves gathering information about : New product or service creation
Process of New Product Development ,R & D Markets Targets Customers ,Market share, Factors affecting demand in the targets market ,Segmentation, Seasonality Competition Market Share of the competitors Sales Information on Targets Sales forces' salary, compensation pattern etc People/Organizational matters Number of employees ,their functions ,trained or untrained workforce
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Financial Due Diligence
Analyses the financial performance of an entity. Involves in-depth analysis of the balance sheet ,cash,
marketable securities ,receivables, inventory ,prepaid expenses and other Fixed ,Current assets . On the liability side the analysis covers accounts payable ,taxes and debt obligations are closely examined Also analyses contingent liabilities
M&A
Prof.Sonali
3/28/2012
Financial statements commonly consist of the following items: Income statement Balance sheet Cash flow statement Notes to the financial statements Key performance indicators (KPIs) based on financial statements and their development over time, provide good measures for the reasons behind positive or negative performance of a business: Gross margin Operating margin Working capital days Debt Equity ratio
M&A
Prof.Sonali
3/28/2012
Financial statements are typically the basis for determining
valuation Identify inconsistent accounting policies Understand the estimates and judgments used in reported numbers Identify matters that impact valuation To advise on the level of EBITDA/EBIT
M&A
Prof.Sonali
3/28/2012
Sales by region/ customer/ product Volumes Prices Cost of sales Raw
materials (such as volumes, prices, supplier dependency) Manufacturing costs (costs per unit) Margins by region/ customer/ product Overhead costs - Fixed Vs Variable EBITDA/EBIT development over a number of period
Prof.Sonali 3/28/2012
M&A
Inventory valuation Debtors ageing and provisioning Nature of long and short term advances Liabilities Payment terms Provisioning policy Fixed assets Degree of depreciation Capital expenditure Working capital items impact purchase consideration Cash flow impacts Seasonality
price
M&A
Prof.Sonali
3/28/2012
Key issues in FDD
Revenue drivers and recognition issues Cost drivers and accrual issues Depreciation policies adopted Valuation of current assets Adequacy of accruals Advance Tax / Provision for Taxation Contingent liabilities and off balance sheet items
M&A
Prof.Sonali
3/28/2012
FDDs Relation with Other DDs
Framework of Due Diligence is designed for Client Success Commercial due diligence compares future business plan and
revenue potential with the industry trends Cost assumptions may be tested through technical and Operational due diligence Various costs impact profitability e.g. employee related matters could be tested through HR due diligence Legal due diligence helps in spotting various hidden issues like arrangements with associates and stakeholders Financial Due Diligence overlaps with all other areas of Due Diligence and should not be conducted in isolation
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M&A
Prof.Sonali
3/28/2012
Legal Due Diligence
Consists of scrutiny of all or specific parts of the legal
affairs of the target company with a view of uncovering any legal risks and provide the buyer with an extensive insight into the companys legal matters
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M&A
Prof.Sonali
3/28/2012
Documents/Areas to be verified
IT law and IT contracts IP rights Patents ,copyrights and other IP related documents Company law Finance Employment law Data Protection law
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M&A
Prof.Sonali
3/28/2012
Documents/Areas to be verified
Consumer Protection law General contract law Minutes and consents of the board of directors and
shareholders Confidentiality and invention assignments and agreements with employees Tax and Financial documents Legal disputes and other kind o f conflicts National and EU competition laws Marketing practices regulation
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HR Due Diligence
It is a process that aims at assessing the contribution of HR
function to the success of the business in a purchasing, outsourcing or market testing environment
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M&A
Prof.Sonali
3/28/2012
HR Diligence helps in following ways
Establishing a link between organizational objectives and
the HR function Determining HRs influence on the skills and motivation of the workforce Determining managers views of the HR function Measuring the adequacy of HR measures ,metrics and benchmarks Ascertaining total cost of HR function and industry comparisons Ascertaining the HR team structure ,skills and motivation
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M&A
Prof.Sonali
3/28/2012
HR Due Diligence aims at seeking answers to the following issues : Analyzing HR structure and policies in the target company Ascertaining whether the target company possess human
resources to support the products, technology, markets or goodwill Evolving an action plan to retain key individuals after the merger Evolving a strategy action plan to integrate the target companys HR processes and culture with the buyer company quickly and smoothly to minimize uncertainties among employees and demonstrate value to the customers
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M&A
Prof.Sonali
3/28/2012
HR Due Diligence aims at seeking answers to the following issues : Evolving the right approach information to make staffing
and organizational decisions quickly to avoid unnecessary anxiety ,destructive rumours and unwanted departures
Visualize
the skills, experience ,knowledge ,specific industry experience and contacts that may be lost post merger ,determine the impact of these potential losses and designing coaching ,employee development or recruiting plans to replace key competencies .
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M&A
Prof.Sonali
3/28/2012
IT Due Diligence
There are four steps to due diligence preparation 1. Sending an IT request list to the acquired company 2. Compiling an onsite discovery process outline 3. Conducting a review of the requested materials 4. Scheduling and coordinating the onsite visit The primary objective of the IT due diligence effort is to maximize the opportunity to discover relevant issues surrounding the companys technology and accordingly initiate corrective measures
M&A Prof.Sonali
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3/28/2012
IP Due Diligence
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M&A
Prof.Sonali
3/28/2012
Introduction: What is IP?
Most creations resulting from human endeavors in various fields of art, literature ,science and technology constitute Intellectual Property
Ownership Valuable Assets Intangibles
Special Rights
Intellectual Property
Time & cost intensive
Transferable
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Additional Profits
Trademark & domain names
Copyright
Trade secrets
Patent
Categories of IP rights
Utility model/Designs Geographical Indications
Plant Breeders rights
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Different Acts governing IP assets
Trade Marks The Trade Marks Act, 1999 The Patents Act, 1970 The Copyright Act, 1957 The Designs Act, 2000 The Geographical Indications Of Goods Act, 1999 The Protection of plant varieties and Farmers Right Act, 2001 Semi conductor IC layout design Act,2000
Patents
Copyright
Designs
Geographical Indications Plant Varieties Semi conductor IC layout
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IP due diligence in Mergers & Acquisitions
IP Due diligence is the process of investigating a partys
ownership, right to use, and right to stop others from using the IP rights involved in sale or merger ---the nature of transaction and the rights being acquired will determine the extent and focus of the due diligence review.
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Seth Associates, 2006 All Rights Reserved
Due-diligence should reveal
Who owns the rights? Are the rights valid and transferable and enforceable? Are there any agreement or restriction that prevent the party
for granting rights to other? Is the property registered in the proper office? Any shortcoming or default on payment? Any past or potential litigation? Has the property being misused in the past rendering right unenforceable? It should also evaluate agreements material to the companys business that may be affected by change of control, agreements that may vest rights in intangibles, and company policies and practices.
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Due Diligence Team
Key requirement in evaluating a possible M & A is a strong
due diligence team capable of carrying out a quick and effective review of the assets after the confidentiality agreement has been attained . Composition of an effective due diligence team will vary greatly depending on the asset to be reviewed . If the team lacks the right persons, the very purpose of due diligence stands defeated .
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M&A
Prof.Sonali
3/28/2012
The team members should have following attributes
Must have first hand experience in the industry to which
the target belongs The team should have experts from different areas such as HR specialist ,functional area managers ,individuals with knowledge of the national and organizational culture etc .Such expertise is valuable and helps the team attain the buy-in from line management which can be hard to get if a key functional area is shut out of the integration process Team should be capable of quickly identifying the positive and negative aspects of the property to be acquired
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M&A
Prof.Sonali
3/28/2012
Members should be willing to carry out a site visit to evaluate
the current condition of the assets to be acquired both physical assets as well as the personnel Should possess excellent negotiation skills Should have time to lead the project and serve as team members Team should be co-located within a secure environment such as corporate headquarters
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M&A
Prof.Sonali
3/28/2012
Team should be familiar with strategic and financial rationale
behind the acquisition Should be trained to identify and zero in on specific issues including the analysis and data required Care should be taken to develop and communicate rules of engagement between the diligence team and the target company .This avoids cultural conflicts and ensures that the team acts in a manner that reflects the acquirers intentions The team should get analytical tools and techniques so that it can rapidly get its arm around potential synergies and integration challenges This helps the team complete its task within the allotted time and budget
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M&A
Prof.Sonali
3/28/2012
There must be a healthy flow of information from the due
diligence team to the integration team . Therefore include due diligence team members in the integration planning team to ensure that diligence rationale and data analysis are properly leveraged
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M&A
Prof.Sonali
3/28/2012
Why does due diligence fail ?
It is a challenging task Quite often the team handling it goes off track giving
disastrous results
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M&A
Prof.Sonali
3/28/2012
Three themes of Failure
Failure to focus on key issues Failure to identify new Opportunities and Risks Failure to Allocate Adequate /Right Resources
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M&A
Prof.Sonali
3/28/2012
Failure to focus on key issues
Irrelevant data collection New Method of Analysis
,instead use tested diligence methodology ,standardized formats and simple software Team reluctant to share information among team members Sharing resources helps in quickly identifying deal killers
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M&A
Prof.Sonali
3/28/2012
Failure to identify new Opportunities and Risks
The
team should test the key assumption of the management before proceeding with the task ,helps in remaining focused . Should probe deeply into the merits of the deal to identify the value drivers and key risks . Dont rely solely on information provided by the target company; collect information from other sources customers, vendors ,employees
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M&A
Prof.Sonali
3/28/2012
Failure to Allocate Adequate /Right Resources
Put the best people on the team ; right expertise ,functional
areas that would be affected by the deal Dont set arbitrary deadlines ;time needed to research review and report Provide adequate resources such as space to work ,equipment, software ,staff and access to the right data and people. Relieve them of their daily responsibilities so they can focus on the task at hand
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M&A
Prof.Sonali
3/28/2012
References
Mergers and Acquisitions Rajinder Arora ; Oxford
publication
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M&A
Prof.Sonali
3/28/2012
