Due diligence is generally conducted by investors to check for regulatory and process compliance by the company regularly. Due diligence of a company is generally performed before any private equity investment, business sale, bank loan funding, etc.
In this process, the legal, financial, and compliance aspects of the company are usually reviewed and documented. It is the process of examining all the material facts of a deal or a contract before a legal contract is signed by both parties. It is not just limited to the buyers; even the sellers can perform due diligence on the buyer. Due diligence consists of factual, background, legal, and accounting checks. This is done to ensure that there are no surprises after a deal is done.
Broadly speaking, there are 3 types of due diligence-
Business due diligence: It looks into the quality and business prospects of an investment and the parties involved therein.
Legal due diligence: It looks into the legal issues/aspects and regulatory aspects involved in intra-corporate and inter-corporate transactions.
Financial due diligence: It validates financial, operational, and commercial assumptions taken by the company. This process also involves a complete review of audit practices, accounting policies, internal controls, and tax compliances of the target company.
The findings obtained from the process of due diligence are summarized in a report termed as the due diligence report.
What are the Important Aspects of a Due Diligence Report?
Certain important aspects of a due diligence report are as follows-
- Monetary Aspect: The report should rely on certain important financial data and precise ratio analysis to understand the entire picture related to the target company.
- Viability: The business and financial plans of the target company should be studied thoroughly to assess the viability.
- Personnel aspects: The report should make a thorough assessment of the credibility and capability of the people operating the company.
- Environmental aspects: No business can separate itself from the environment around it. Therefore, it is important to study the environment and its overall impact on the company concerned.
- Technological aspects: Assessing the technology available to the company at a given point of time is another important part of the due diligence process. Such an assessment would help a great deal to decide the future course of action.
- Liabilities: The report should take into account any existing and potential liabilities (including regulatory issues, pending litigations, and so on) the company may come across.
Documents Required for Due Diligence
The following documents are required for successful completion of the due diligence process in India-
- Charter documents of the company
- Notices, Attendance Sheets & Board Meeting Minutes
- Notices, Attendance Sheets & General Meeting Minutes
- Statutory Registers
- Legal Agreements executed by the Company
- RBI Related documents
What are the steps of the due diligence of a company?
The due diligence process of a company consists of the below-mentioned steps-
Assessment of MCA Documents
The due diligence process of a company begins at the Ministry of Corporate Affairs (MCA). On the website of the Ministry of Corporate Affairs, the master data about a company is made publicly available. Further, with the payment of a small fee, all documents filed with the Registrar of Companies are made available to everyone. This information from the MCA website is generally verified first. The information and documents gathered in this step include:
- The date of Incorporation
- Authorized capital
- The paid-up capital
- The date of the last annual general meeting
- The date of the last balance sheet
- Status of the company
- The directors of the company
- The date of appointment of directors
- The details of secured lenders of the company
- The quantum of secured loans
- The certificate of incorporation
- The memorandum of association
Articles of association
In addition to the above, the financial information of the company and other filings with the MCA about various aspects of the company can be downloaded and reviewed. The review of MCA documents of the company would provide a good overview of the company to the person performing the due diligence.
Assessment of Articles of Association (AoA)
It is imperative to review the articles of association of a company during the due diligence process to establish the different classes of equity shares and their voting rights. The articles of association of a company can restrict/limit the transfer of shares of a company. Therefore, the articles of association should be studied judiciously to ascertain the procedure for transfer of shares.
Assessment of Statutory Registers of Company
Under Companies Act, 2013, a private limited company is required to maintain various statutory registers relating to the share transfer, share allotment, board meetings, the board of directors, etc., Therefore, the statutory registers of a company must be reviewed to obtain and validate the information about the directorship and the shareholding.
Assessment of Book of Accounts and Financial Statements
Companies are required to maintain the book of accounts along with detailed transaction information by the Companies Act, 2013. The detailed financial transaction information must be audited and verified against the financial statements that are prepared by the company. Some of the matters relevant during the preparation of the due diligence report are:
- Verification of the bank statements
- Verification and valuation of all the assets and the liabilities
- Verification of the cash flow information
- Verification of all the financial statements against transactional information
Assessment of Taxation Aspects
The taxation aspects of a company must be thoroughly checked during the due diligence process. This helps to ensure that no unforeseen/unexpected tax liabilities are created on the company on a future date. The following aspects relating to the taxation aspect of a company must be checked while preparing the due diligence report :
- The income tax return filed
- The income tax paid
- The calculation of the income tax liability by the company
- ESI / PF returns filed
- ESI / PF payments
- ESI / PF payment calculation
- The GST/service tax / VAT returns filed
- The GST/service tax / VAT payments
- The basis for the GST/service tax / VAT payment calculation
- TDS returns
- TDS payments
- TDS calculations
Assessment of Legal Aspects
A complete legal audit of the company has to be performed by a certified legal practitioner to establish if there are any pending/incomplete legal actions, suits by or against the company, and the liability in each of these. Further, the following aspects must be checked during the legal due diligence:
- Legal due diligence for all the real estate properties of the company.
- No objection from a secured creditor for the transfer of the company.
- Verification of the court documents and the court filings, if any
Assessment of Operational Aspects
It is important to acquire a thorough understanding of the business operations, business model, and operational information during the process. The review of the operational aspects must be all-encompassing including the site visits and employee interviews. Following are the points that must be covered and documented in the review of the operational aspects:
- Business model
- Number of employees
- Number of customers
- Production information
- Vendor information
- Machinery information
FAQs on Due Diligence of Company
Is it mandatory to conduct due diligence before the investment?
Yes, it is appropriate to know if the legal compliances made by the Company are up to date, before entering into a shareholder’s agreement with the Company.
How to handle the non-compliance, if any?
No worries! We will provide the solutions on case to case basis.