Due Diligence for the Acquisition of an Indian Company

Before diving into any kind of agreement or contract, it is imperative that either party involved does the due diligence that is needed to avoid any potential disagreements or conflicts in the future. This due diligence is mandatory to avoid any blame-game in case of issues and no party is held liable for any damage or loss faced as a result of the agreement/contract signed.

Read on to familiarize yourself with various aspects related to due diligence for the acquisition of an Indian company.

What is Due Diligence?

• Due diligence basically helps the buyer make a more informed decision when it comes to purchasing any property/product and know exactly what they are buying before investing their money into it.
• When it comes to buying a company, it is the responsibility of the acquirer (buyer) to perform due diligence related to the sale agreement. It is the responsibility of the seller to provide all the necessary documents required by the buyer to perform the due diligence.

Why do you need Due Diligence?

• Due diligence helps acquire valuable information about the business you plan to acquire and unravel any potential fact that can impact your decision to buy the company.
• It can play a major role in defining the price of the business and learn when it may become an overbearing investment for you.
• It affects decision like whether you should invest or not, which venture partner to choose and what should be disclosed in an offer document.
• Considering ‘Knowledge is Power’ in our world today, due diligence helps make sure no vital detail misses your eye and you have all the information needed for the deal. It gives you the upper hand and define the risks associated with the entire deal.

 

What are the Tools of Due Diligence?

• One of the most effective tools is sharing a questionnaire that targets the company you plan to buy to learn about the general aspects and various risks associated with the business of the company. The buyer creates a questionnaire and gives it to the company, based on which, a one-on-one discussion can be conducted.
• Another method is to ask the seller to make representations of company data in the commercial contract. This is also known as the ‘Data Room’ method, where a large amount of business-related information is presented to potential buyers to view, evaluate and perform the due diligence needed. This allows business owners to present the same information to all potential investors and ensure they know everything that the other investors know.

Note: This ‘Data Room’ method plays an excellent role, especially in case of disinvestments and makes sure you share equal information with all investors without potentially being biased towards anyone.

After going through the responses of the questionnaire or examining and evaluating the data room, a due diligence report is prepared, based on which the various details of the transaction are negotiated.

Process of Due Diligence

Here is how professionals conduct the due diligence necessary for acquiring a company:

• Setting Terms of Engagement: Due diligence terms are decided and a non-disclosure agreement is signed between the two parties involved.
• Due Diligence for Operations: Operational data and details like customer base and cost structure are calculated, collected and documented.
• Due Diligence for Finances: Financial data and details like revenue expenses, profitability and cash flow are collected, double-checked and documented.
• Legal Due Diligence: Legal and regulatory data and details like tax payments and litigations are collected, checked and documented.
• Reporting the Findings: All the findings of the previous steps of due diligence are shared with the acquirer (buyer) and, if needed, even to the seller.

 

Contents of a Due Diligence Report

The information stated in a due diligence report usually concerns:

• Company information.
• Corporate capacity.
• Directors, their interests and, if any, conflicts.
• Accounts.
• Statutory compliance with the applicable regulations.
• Personnel.
• Share capital.
• Shareholders.
• Licenses, permits, approvals and specific statutory compliance.
• Litigation – judicial, quasi-judicial, arbitral and other administrative proceedings.
• Taxation issues – income tax, customs, excise and sales tax.
• Insurance – quality of insurance cover.
• Contractual liabilities and commitments.
• Intellectual property rights – identifications of all patents, trademarks, copyrights, industrial designs, all other forms of registered and unregistered intellectual proprietary rights or other form of monopoly or property rights used or owned by the target company and rights granted to third parties.
• Compliance with the Payment of Bonus Act 1965, the Industrial Disputes Act 1947, the Payment of Wages Act 1936, the Employees Provident Funds and Miscellaneous Provisions Act 1952, the Employees State Insurance Act 1948, the Payment of Gratuity Act 1972, and the Local Shops and Establishments Act; as well as with any industrial settlement, award, judgment or order in any labor dispute or litigation; recognized trade unions; retrenchments, lay-off and voluntary retirement schemes; and share options, share incentive, profit sharing or other incentive schemes for employees; pension, retirement, provident fund, superannuation and gratuity schemes.
• Industrial property – trade secrets & know-how.
• Infringement of third-party rights.
• Assets – immovable and movable property.
• Exports and imports, compliance with laws.
• Environment-related issues – compliance with law, social issues, and the rehabilitation of people that are prone to be ousted by large natural resources projects, for example, a reservoir for a hydroelectric project.

 

What to keep in mind when managing the Due Diligence Process?

There are various aspects of the diligence process that must be managed to avoid any potential errors in the final report. Here are the aspects that must be managed during the due diligence process:

 

Initial Parameters

A set of areas must be defined that will be of primary importance during the due diligence process. They are the parameters that the due diligence team will inspect when conducting the due diligence and may include aspects like key personnel of the company, suppliers, customers, and the continuity of business targets.

 

Due Diligence Team

It is the core team responsible for carrying out the due diligence and may consist of the following personnel:

• Legal team of the buyer
• Valuation advisor of the buyer
• Merchant Bankers/Chartered Accountants of the buyer
• Management representative of the buyer
• Technical consultants of the buyer

The allocation of roles, responsibilities and resources will be carried out at this stage as well.

Note: All external personnel involved with due diligence are required to sign a confidentiality agreement before they begin working.

Preliminary Investigation

The key role of this primary round of investigation is to unravel any potential issues that can play a major role in the entire sale and purchase of the company. This is done to avoid getting into the deal and investing valuable resources for investigation. A few issues that may be found as a result of this investigation are:

• Insufficient internal controls.
• Cases of misunderstanding or non-compliance of contracts, accounting principles, policies, standards, legal provisions.
• Contingent liabilities.
• Legal proceedings.
• Erosion of net worth of the company.
• Employee retention.
• Core management succession.

Detailed Due Diligence

This stage involves conducting an extensive and detailed due diligence for the purpose of finding various details that might affect the business deal. The entire transaction depends upon the findings of this investigation as it will play the key role in helping the acquirer make an informed decision related to whether they will be buying the company or not.

 

Disclosure Completeness Certificate

A declaration or certification stating that all data, documents and details have been shared must be shared by the target company and given to the due diligence team. This certificate will confirm that all the information has been shared with the investigating team and nothing has been left out.

Documents Required for Due Diligence of Companies

The documents required to efficiently perform due diligence are:

• Memorandum of Association
• Articles of Association
• Bank Statements
• Income Tax Returns
• Shareholding Pattern
• Tax Registration Certificates
• Tax Payment Receipts
• Financial Statements
• Certificate of Incorporation
• Property Documents
• Intellectual Property Registration or Application Documents
• Statutory Registers
• Utility Bills
• Operational Records
• Employee Records

 

MCA Documents Review

The master data of all companies is available online on the Ministry of Corporate Affairs (MCA) website. This information is usually the first set of details reviewed as part of due diligence process. The documents and details gathered and reviewed at this stage are:

• Date of Incorporation
• Authorized Capital
• Paid-up Capital
• Date of Last Annual General Meeting
• Date of Last Balance Sheet
• Status of the Company
• Details of Secured Lenders of the Company
• Quantum of Secured Loans
• Directors of the Company
• Date of Appointment of Directors
• Articles of Association
• Memorandum of Association
• Certificate of Incorporation

Note: In addition to the above-mentioned details, the financial information and other filings of the company can be accessed, downloaded and reviewed from the MCA website as well. All the information related to a company filed with the Registrar of Companies can be viewed by paying a small fee.

Challenges in Conducting Due Diligence for Acquisition

Some of the challenges faced when conducing due diligence for the acquisition of an Indian company are:

• Lack of an ample amount of basic data that makes the process more tedious.
• Confidentiality/secrecy agreements, which often prevent complete disclosure of crucial documents.
• Hindrances in getting or sharing proprietary information.

Some minor challenges faced during the process include:

• Language barriers.
• Travels to remote locations.
• Individuals who are not happy or aware of the planned transactions.

Strategically and professionally managing the due diligence process is key to avoiding and overcoming these challenges.

Conclusion

Considering the crucial importance of the due diligence exercise, it is imperative to take all the necessary steps that would help get the most accurate results. Some steps that would help gain top-notch results are:

• Clearly state objectives.
• Formulate strategic plans.
• Create different teams of personnel for the project – project management, data management, the core due diligence team, and support team.
• Lay down the guidelines for each team and plan out for a clear allocation of responsibilities.
• Follow a unified approach and rely on technical experts’ advice whenever necessary.
• Use apt technology to collect, analyze, index, and retrieve data.
• Do not step back from asking questions or from clarifying anything.
• Continue the due diligence process until after the transaction is complete.
• Media reports must not be given too much consideration – neither value them too much nor ignore them completely.

We can assist you with due diligence concerns related to the acquisition of an Indian company. You can get in touch with us by submitting a query below.