*by Rahel Roy
In common practice, any prudent man who purchases any goods and services will check if the product he is buying is worth the value of the product before the purchase. He may decide to buy the product on the basis of utility, price, alternatives available and other factors according to his demand. This same principle of examining a product before purchasing it is applied by the companies during Merger and Acquisition transactions. The companies undertake a very rigorous process before acquiring another company to check the feasibility and the existing and potential exposures of the transaction. This process is known as “due diligence”.
The dictionary meaning of the word due diligence means “action that is considered reasonable for people to be expected to take in order to keep themselves and others safe”. Therefore, through this process the acquiring company makes sure before the acquisition of the target company that the transaction does not cause any damage to the acquiring company due to any exposure that was overlooked by the acquiring company or concealed by the target company.
IMPORTANCE OF DIFFERENT TYPES OF DUE DILIGENCE –
- During Legal Due diligence potential or existing legal issues can be identified with the help of legal professionals by carrying out thorough examination of the contracts,memorandum and articles of association, intellectual properties and pending litigations of the target company. This helps the acquirer to prevent legal complications and huge litigation costs post acquisition. Through legal due diligence the acquirer can also figure out the regulatory and sectoral compliances required for the merger and acquisition transaction.
- By checking the financial statements of the target company the acquirer can estimate the true value of the company , which will consequentially be helpful for the acquirer to make an offer for the suitable purchase price of the target company. Private companies do not have an obligation to make their financial statements accessible to the general public which makes thorough financial due diligence of the target company , if it is a private company , to be very important aspect of the due diligence process because it may attempt to cook the books away from the public eye. The tax liabilities of the company can also be detected through financial due diligence and the acquirer can identify if there is any tax evasion by the target company which may become a liability for the acquirer post acquisition. Financial due diligence is undertaken by accountants, auditors and tax counsels.
- Business due diligence helps the acquirer to identify various business strategies, such as , marketing, advertising, sales, etc. of the target company. This helps in formulating proper business plans for carrying out the acquired business post the merger and acquisition transaction. This kind of due diligence helps in devising a proper roadmap to make the acquisition of a company profitable by carrying out its business smoothly and in a better way by keeping the consumer’s satisfaction of the target company in mind.
- Operational due diligence helps in identifying the internal operational practices of the target company .
- IP Due diligence helps the acquirer to look at all the trademarks,patents and copyrights possessed by the target company and any dispute pending with regard to such IP rights .
- Human Resources Due Diligence deals with employment contracts of the target company and it gives an insight to the acquirer about the salaries and allowances and other benefits assured by the target company to its employees and whether the acquirer wants to retain the employees of the target company and if it does , whether on the same conditions mentioned in the contract of employment as the target company.
- IT due diligence of the target company helps in assessing the It Infrastructure of the company and helps in detecting how the company protects data and if the acquirer needs to upgrade the IT infrastructure of the target company post acquisition .
CONSEQUENCES OF FAILURE IN UNDERTAKING DUE DILIGENCE PROCESS-
If any company fails to carry out proper due diligence during a merger and acquisition transaction then that company is more likely to be exposed to various threats from different facets of business. For example, when company A who is going to acquire company B carries out due diligence process negligently and finds out after the acquisition that Company B was involved in IP litigation before the transaction took place and it is still pending. Now Company A will have to bear the litigation expenses and it will not also have the IP if they lose the litigation.
When an UAE based telecom operator Etisalat acquired 45% stake in Indian telecom operator Swan Telecom (renamed as Etisalat DB) for $900 million and the Supreme Court revoked the 2G licenses issued to Swan Telecom , Etisalat had to shut down its operation in India. On Feb 9,2012 the UAE firm wrote off $827 million relating to Etisalat DB. Etisalat issued legal proceedings against the promoters of Swan Telecom (renamed as Etisalat DB) on the grounds of fraud and misrepresentation. This could have been avoided if Etisalat carried out proper due diligence to find out detect the discrepancy in attainment of 2G Licenses by the promoters of Swan telecom.
In the case of acquisition of Autonomy, an UK based software company by Hewlett- Packard(HP), an US based software company which was valued at $11 billion dollars , HP had carried out only six hours of due diligence on the finances of Autonomy. HP later found out that Autonomy had cooked its books for overvaluing the company during valuation. HP wrote down the Autonomy purchase as a nearly $9 billion loss. This is a typical example of how the examination of the books of the company is important while carrying out financial due diligence which may help the acquirer to detect any discrepancies present in the financial statements of the target company
In 1994 when Quaker acquired Snapple which was famous for its bottled teas and juices it failed to realize the true value of the target company and ended up overpaying while purchasing the company for $ 1.7 Billion. Quaker wanted to use their distribution channel of large retailers and supermarkets but they failed to realize that Snapple was mostly sold by small retailers . The advertising strategy of Snapple also suffered because managers of the acquiring firm were not aware of the branding and positioning of the product. The Competitors ate a large part of the product too.
In just 27 months, Quaker Oats sold Snapple to a holding company for a mere $300 million, or a loss of $1.6 million for each day that the company owned Snapple. By the time the divestiture took place, Snapple had revenues of approximately $500 million, down from $700 million at the time that the acquisition took place
This M&A deal proved that it is very important to carry out proper due diligence with respect to the existing business strategies and positioning of a product in the market because acquiring companies need to formulate efficient strategies in order to retain old customers and create new ones after the acquisitions. It is also very important to do a competitive analysis of the company to figure out a plan to be ahead of them post acquisition.
Due Diligence is the pillar of all Merger & Acquisitions transactions. Companies need to hire qualified professionals in varied fields for carrying out due diligence process to ensure smooth transfer of the assets and liabilities of the target company and successful post merger business operations. Proper Due Diligence process helps to identify if at all the acquisition of the target company is commercially feasible and the acquiring or transferee company do not suffer losses due to the transaction.
India has seen a huge number of Mergers and Acquisitions deals recently. The companies involved in these deals are not only native but some of them are also foreigners. Indian Companies are now looking for global expansion through the M&A deals . The proof of this is the acquisition of companies like UK based companies like Land Rover,Jaguar,Corus and Tetly by Tata group or Byju’s acquisition of US based ed-tech company Osmo’s. While acquiring a foreign company due diligence process becomes more elaborate and significant because the acquirer has to observe the compliance of both the target country’s and the acquirer country’s regulations regarding the Merger and Acquisition.
Due diligence is the most important process involved in a M&A deal and its execution needs to be done with utmost sincerity to prevent any mishaps during the deal or after.