ddr presentation for239482934

7/29/2019 DDR Presentation For239482934

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DUE DILIGENCE


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Contents Meaning of Due Diligence

Review (DDR)

Due Diligence What is it?

Scope of DDR Who Conducts DDR

Situations calling for DDR

Types of DDR

Introduction to Financial DDR Types of Financial DDR

Process involved in FinancialDDR

Areas covered in FinancialDDR

Practical Situations in DDR

Findings and their Impact Impact of findings from other

Due Diligences

Limitations

Risks Involved Steps to Mitigate Risks

Reporting


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Meaning of DDR Dictionary Meaning of Due is Sufficient & Diligence

is Persistent effort or work.

It is an investigation into the affairs of an entity prior toits acquisition, flotation, restructuring or other similartransaction

Due Diligence Review is a process whereby an individualor an organization seeks sufficient information about a

business entity to reach an informed judgment as to itsvalue for a specific purpose.


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Due DiligenceWhat is it? The process by which information is gathered

about:

A target Company Its Business; and

The Environment in which the target companyoperates

Objective: To ensure that prospective investors make and

informed investment decision


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Due DiligenceWhat is it? It is a business oriented analysis not an accounting

analysis

A fact gathering exercise with focused analysis ofinformation

Understanding the industry of the target

Reasonable level of enquiry on the affairs havingmaterial impact on the prospects of the business

Evaluation of business model and key business practices


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Scope of DDR Scope is determined by the client.

The degree of diligence requiredin any given review cannot beprecisely defined.

Purpose for review defines whatis due or sufficient diligence.

Extent of the review required is ajudgment call.

Engagement letter with the clientis important.


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Who conducts a DDR Chartered Accountants

Investment Bankers

Attorneys Lead & Co-Investors

Corporate Development Staff


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Situations Calling for DDR Firm considering a potential

acquisition

Investment banker considering

underwriting a public security Banker considering the grant of a

loan

Venture Capitalist considering an

Investment Seller of a business commissioning a

DDR

Lead Investment Banker in case ofIPO as per SEBI Norms


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Business Due Diligence

Legal Due Diligence

Tax Due Diligence

System Due Diligence

Environmental Due Diligence

Human Resource Diligence

Financial Due Diligence

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Types of DDR


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Business Due Diligence A review of the market for the company's product

A background check on the founders and key management team

Analysis of the Company's competition

Existing Market Share

Expansion plans

Analysis of Comparative Profitability & reasons for deviation ifmaterial

Discussions with the Company's key customers

Review of management structure

High dependence on single customer/supplier

High dependence on Government policies10

Types of DDR


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Legal Due Diligence

Looks at identifying issues related to contractual obligations

which have not been fulfilled by the Company. Review of key contracts related to customers, suppliers,

employees and services.

Review of agreements/filings related to patents, copyrights,

trademarks, intellectual property rights, etc Compliance with the Companies Act and various other statutes

applicable to the Target

Review of Litigation for and against the Company.

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Types of DDR


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Tax Due Diligence

Identifies and quantifies areas of tax risk to the extent possible

and assesses future tax implications Deals not only with historical liabilities but also assesses future

tax implications and finds opportunities to minimize tax

Tax implications of the various possible structures

Tax DDR is a key ingredient in assessing whether to proceedwith a deal

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Types of DDR


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System (IT) Due Diligence

Confidence that the IT assets supporting the business are up to

the task Review the framework for hardware and software

Review of the Disaster Management Plan

Coordination that all the softwares are working in sync and

there is no conflict between any of them. Advise on system integration with the acquirers information

system

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Types of DDR


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Environmental Due Diligence

Environmental due diligence is the systematic identification of theenvironmental risks and liabilities associated with an organisation'ssites and operations

Provides the acquirer with a detailed assessment of the historic, current andpotential future environmental risks associated with the target organisation'ssites and operations.

Review the environmental setting and history of the site

Assess the site conditions, operations and management

Confirm legal compliance and pollution incidents from regulatoryauthorities

The internal environmental norms of the acquirer are met

Review contractual and other associated risks14

Types of DDR


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Human Resource Due Diligence

Human resource due diligence attempts to evaluate how people aremanaged between the two companies

How do we continue to maximize the value of human resource capital?

What is the appropriate mix of pay and benefits for the neworganization?

What incentive programs are needed to retain essential personnel after

the acquisition is announced? How are employees rewarded and compensated by the Target Company?

How does base pay compare to the marketplace?

Review of comparative pay scales and designations between the acquirerand target company.

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Types of DDR


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Financial due diligence has the highest significance the finaldecision, for an investor, would be in the form of financial termsand information. It is therefore imperative that the results of all

kinds of due diligence should be translated in monetary terms.

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Introduction to Financial DDR

Identification of hidden risks & deal breakers

Ensuring that all liabilities, current and contingent, are considered

Establishing price adjustments / negotiation extent of dependency on

customers and vendors Off balance sheet financing

Identification of specific indemnities & warranties reqd. from target


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Buy Side Due Diligence commissioned by the acquirer

Focused on areas of interest for potential acquirers (financial orstrategic)

Reporting generally issue based

Dataroom < > exclusive

Sell Side (Vendor DD) Independent due diligence commissioned by the vendor

Key tool for maximising saleability of the business in a reducedtimetable through maintaining competitive tension

To identify potential issues and take corrective measures upfront

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Types of Financial DDR


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Limited Not equivalent to full scale due diligence

Focus on certain key areas based on the level of comfort desired bythe Client

Full Scale Focus on all major aspects of financial statements

Extent of detail is more as compared to limited due diligence

It is important to know whats driving value foryour clients

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Types of Financial DDR


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Methodology

QuickAppraisal

Terms ofReference

InformationChecklist

Field WorkIdentifying

IssuesReplies fromManagement

Preparation ofDraft Report

Discussion ofDraft Report

Issue of FinalReport


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Areas in Financial DDR This would typically assess the effect the external factors

have upon business. This when compared with theinternal strengths and weakness, provides a good

understanding of the state of business. External factorsgenerally include markets, competition, regulation andtechnology.

Business

Environment

This would involve understanding the business model of

the target and the value chain of its business. Other thanthe main value creating functions viz. procurement andits logistics, production, marketing and sales anddistribution logistics, attention is also given to thefunctions that support these activities.

CompanyOperations


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Areas in Financial DDR Evaluation of the build up of operating profits Identifying key sensitive parameters which would

adversely impact the profitability of the business

The rate of growth in sales, EBITDA and earnings Sustainability of earnings / cash flows Normalised EBITDA / Proforma financials

Quality of

Earnings

Analysing cash flows generated from operations and howthe same are employed

Understanding the level, stability, timing and certainty offuture cash flows

Analysis of working capital along with discussion onnormal, average level of working capital

Cash Flows


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Areas in Financial DDR Analysis of fixed assets -Capitalisation, depreciation

and replacement policies; Capex plan, capitalcommitments

Investments made, carrying value, valuationpolicies and potential diminution in the value of theinvestments

Receivables (ageing analysis, recoverability, baddebts and provisioning policy)

Inventory (ageing, valuation, write off/provisioning

policies) Cash balance and bank reconciliations Analysis of other current assets like loans and

advances, deposits, cash/ bank balances.

Balance SheetAssets andLiabilities


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Areas in Financial DDR Sundry creditors (ageing analysis, subsequent

payment of creditors dues)

Review of loan agreements to see compliancewith the terms of the lenders guidelines andalso if any conversion clause exists.

Review of all other current liabilities &provisions to see that all known liabilities arefully recorded and all provisions are made.

Shareholders agreement in case of companies Off balance sheet liabilities-bank guarantees,

commitments, legal claims and contingencies

Balance SheetAssets andLiabilities


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Areas in Financial DDR

This would involve various issues related to

taxation to ensure that no undisclosed liabilitiesaccrue to the target

Assessment and validation of losses / other taxattributes

Current compliance status; Tax benefits and their availability in future; and Commentary on any other outstanding tax

liabilities / material issues

Taxation Direct and

Indirect


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Areas in Financial DDR Review of various agreements / arrangementswith related parties and assessment of various

transactions with them Evaluation of commitments to / from relatedparties

Analysis of human resources with respect tohead count and provision for retirementbenefits in line with laws applicable to the same

Review of other arrangements necessary forconduct of business e.g. contractual labour,trade unions, etc

Other Areas


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Fixed Assets

Underused/obsolete plant & machinery

Assets carried at much more than current market valuedue to capitalization of revenue expenditure or foreignexchange fluctuation

Capitalization of interest in an expansion projectsubsequent to stoppage of the construction work

Litigated assets & property

Adjustments for capitalization of assets, softwareexpenses, etc

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Practical Situations


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Investments

Target co. sold subsidiaries/business & agreed to takeover and indemnify all liabilities of the same prior to thedate of transfer, which were not reflected in the targetsbooks of accounts

Investments carried at cost though realizable value ismuch lower

Investments carrying a very low rate of income/ return

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Working Capital

Uncollected/ uncollectible receivables

Obsolete, slow & non-moving inventories or inventoriesvalued above Net Realizable Value

Adjustment for Inventories with old names/logos in thecase of hotel industry

Group company balances under reconciliation, etcDeferred Revenue Expenditure

Deferred revenue expenditure included under advancesor not normally deferrable

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Taxes

Tax liabilities under Direct & Indirect taxes

Pending final assessment of customs duty whereprovisional assessment only has been completed

Non availability of TDS Certificates

Adjustment for possible liability arising out of non-

submission of Forms C & F Delays and non-payment of direct and indirect taxes

Liability on account of EPCG

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Other Claims

Environmental problems/claims, third party claims

Huge labour claims under negotiation when the labourwage agreement has already expired

Non-funded gratuity/superannuation/leave salaryliabilities

Non-compliance with enactments such as the Income Tax

Act, FEMA/FERA, Customs Act, etc. that could result inlitigation & levy of penalties

Product warranties, defects & other liability claims, productreturns & discounts, liquidated damages for late deliveries

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Off Balance Sheet Items

Target co. may not show any show cause notices whichhave not matured into demands as contingent liabilities.

These may be material & important

Target co. may have given Letters of Comfort to banks& FIs. Since these are not guarantees, these may not bedisclosed in its balance sheet

Commitments including long term contracts

Agreement to buy back shares sold at a stated price

Future lease liabilities

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Profit & Loss Items

Identifying seasonality in sales, dependency on customers

Assessing the impact of customers gained / lost on thebottom line

Dependency on customers/suppliers

Revenue recognition and cut off procedures

Items of one off / non recurring nature Impact of stand alone costs

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The DDR findings are then quantified for impact on the finalvaluation

Deal Breakers - Those issues which would impediment the

consummation of the proposed transaction Negotiation points - Those issues which would be necessary to

consider in the valuation of business / negotiation of bid price

Issues for Agreements - Those issues which would warrantindemnities and identify conditions precedent for happening of the

transaction

Commercial Override - Those risks and issues which areknowingly taken over as a calculated commercial decision

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Findings and their Impact


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The DDR findings from other due diligences mentioned beforealso need to be quantified for impact on the final valuation

Business Due Diligence Impact of dependence on single

customer/supplier, government policies, etc. Impact of expansionplans on future profitability of the company

Legal Due Diligence Any further liabilities/penalties arising outof non compliance/defaults with regards to Corporate laws likeFEMA, Companies Act, SEBI Norms (for listed companies), etc.

Tax Due Diligence Penalties for non-payment, delays in paymentof statutory liabilities. Liabilities arising on settlement ofassessments.

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Impact of Findings from other Due

Diligences


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System Due Diligence Costs involved in case migration of data.Issues related to strengthening of the information system. Issueswith regards to all necessary safeguards being in place when an

emergency occurs Environmental Due Diligence Penalties/liabilities with regards

to non-compliance of environmental guidelines issued by therespective authorities. Costs involved withaligning/synchronization the environmental guidelines of the

acquirer Human Resources Due Diligence Costs involved with aligning

the pay scales of acquirer and target. In case there is excess staff onthe roles of the target then severance costs to be looked into.

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Impact of Findings from other Due

Diligences


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Undertakings should normally cover the following:

Titles & ownership

Various Government consents / licenses

Correctness of all information supplied

Product / service warranties, damages & other claims

Contingent liabilities

Recoverability of all current assets Registration of Intellectual properties

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Undertakings from Management


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For Service Providers

Limited scope of review fixed by the client /acquirerTitles & ownership

Too much to see in too little time

For Acquirers/Investors

Inability to determine the scope Inability to ensure proper co-ordination between service

providers

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Limitations


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For Service Providers

Failing to meet the

needs of the partycommissioning a duediligence

Financial

indemnification of theconsequential loss

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Risks Involved


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For Acquirer/Investor

The investor may pay higher thanthe fair price for acquisition

The investment performance maynot be upto the expectation or mayperform badly

A bad strategic investment may

result in losing a considerablemarket share or reputation

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Risks Involved


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By Service Provider

Clearly understand the objectives& the complexities of the

assignment based on which thescope should be finalized

The DDR report should disclose allthe limitations of the assignment

A proper engagement reviewshould be carried out beforeaccepting the assignment anddeciding the scope

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Steps to Mitigate Risks


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By Service Provider

Schedule meetings with otherreviewers

Collect from the client reports ofall other due diligences

The due diligence team shouldconsist of at least one person who

is familiar with the industry, thetarget is involved in

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By Acquirer/Investor

Should ensure that the scope iscomprehensive

Proper coordination amongst allservice providers should beencouraged

An integrated service provider

may be hired

To ensure that the target providesall necessary information

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Identifying Issues

Identified issues to be discussed with Mgmt & otheradvisors

Replies from Management

Resolve issues identified

Preparation of Draft Report

Draft report submittedDiscussion on the Draft Report

Issue of Final Report

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Reporting Aspects


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Due Diligence plays an important role inidentifying, quantifying and reducing the risks of an

acquisition.

Although Due Diligence focuses on negativeinformation, the aim is not to raise obstacles to

transactions, but rather to facilitate transactions byidentifying problems and risks by devising solutionsto problems or devices to reduce or manage the risks

involved in corporate acquisitions.

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To Conclude ..


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ddr presentation for239482934

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