Due Diligence- Meaning, Types, Documents Required and Process for its Drafting

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INTRODUCTION

Due Diligence ("DD") involves risk and compliance check on companies which include conducting and investigation to review, audit and verify facts and information about a particular subject. In layman's language, DD means acquiring knowledge before entering into an agreement with any company. A DD check includes a detailed investigation of the financial and legal status of the company or a firm or an individual. A DD check is usually needed when a company decides to merge or acquire another company or invest in real estate or are involved with insurance transactions or performs IPO.

There is another concept known as Third Party Due Diligence ("TPDD") which is the process of conducting DD on third party entities such as suppliers, vendors, contractors, agents or business partners before engaging or partnering with them through an agreement. The reason to conduct TPDD is to reduce potential risks and protect the company's reputation. TPDD involves gathering information regarding background, financial stability, legal status, ethics etc. of the third party and potential risks involved. 

TYPES OF DD

The following are the types of DD which are conducted on companies:-

1. Financial Due Diligence- DD regarding the financial, commercial and operational aspects of the company are conducted involving accounting policies, audit practices, tax compliance and internal controls.

2. Legal Due Diligence- DD regarding legal status and legal aspects of a company is conducted. Both domestic and international transactions are covered as well as other law related issues are also taken care of.

3. Business Due Diligence- DD regarding what kind of parties are involved in the business transaction, prospects of business and the investment quality is conducted.

WHEN IS DUE DILIGENCE NEEDED

DD is usually done under the following circumstances:-

1. Partnership- When a company decides to enter into a partnership with another company then DD is conducted to know the risks of entering into such an alliance.

2. Public Offer- When a company wants to make a public offer regarding selling of its shares and securities then DD is conducted regarding decisions on public issues, disclosures in a prospectus, post public issue compliance etc. 

3. Mergers and Acquisitions- When a company decides to merge with or acquire another company then DD is done regarding background, financials, litigation, intellectual property etc. 

4. Joint Venture- When a company decides to enter into a joint venture with another company then DD is conducted regarding the background, financials, litigation, intellectual property, stand in the market, resources' adequacy etc. 

DOCUMENTS REQUIRED FOR DUE DILIGENCE

There are many documents which a company, on which DD is conducted, has to furnish for drafting of DD report:-

1. Memorandum of Association

2. Articles of Association

3. Certificate of Incorporation

4. Shareholding Pattern

5. Authorised and Paid Up Capital

6. Statutory Register

7. Financial Documents (Balance Sheets, Profit and Loss Account, Expense Statement) 

8. Bank Statement

9. Income Tax Returns

10. Property Documents

11. Utility Bills

12. Insurance details

13. IP Details

14. Business Agreements

15. Marketing Information

16. Legal Details (If company is involved in litigation)

17. Tax Registration Certificate

18. Valuation of the Company

19. Employees' Details

20. Directors' Information

21. Charges, if any, are registered

22. Other documents, if any

In India, Ministry of Corporate Affairs ("MCA") administers the Companies Act, 2013, LLP Act, 2008 and Insolvency and Bankruptcy Code, 2016 which governs Companies and Limited Liability Partnerships in India. MCA has a website https://www.mca.gov.in/ which provides all types of service such as incorporation, filing of documents, Director Identification Number for Directors etc. online for companies and LLPs. A Master Data is provided in this website which provides all the companies' information on small payment of fee. 

PROCESS OF WRITING A DUE DILIGENCE REPORT

While drafting a DD report three things have to be kept in mind which are as follows:-

1. Who is the target audience?

2. Objective of your report

3. Aspects for decision making

DD involves a lot of research and patience so that its report is true and fair in all aspects. The following points should be kept in mind while drafting a DD report:-

1. Reference of a DD report template- The best way to go about a DD report is to take reference from a DD template which will help in understanding the format of a DD report.

2. Know your audience- It is very important to know your audience while preparing a DD report. The person reading the report can be a Director or CEO of the company to whom the DD report is sent. He/she may be very busy in other business matters so the report has to be concise and clear to help the audience through the report easily and absorb information. There is certainly a need to include everything in the report which is impossible and also a waste of time as the people reading the report do not have time to read it fully. Focus should be kept on the objective of the company and the DD report.

3. Reference of a DD report template- The best way to go about a DD report is to take reference from a DD template which will help in understanding the format of a DD report.

4. Revision- After completion of the DD report, it should be thoroughly revised to check if anything is missing as any business with another company depends entirely on this report. 

CONCLUSION

DD is very important so it has to be done properly and meticulously. A proper checklist of questions should be prepared before conducting DD as it will help in doing the same in an orderly fashion. A company's reputation depends on how the DD is done which also reflects the position of the company in the economy. 

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