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Types of Due Diligence

Wednesday 10, 06 2020
When an investor wants to invest in a business, they will appraise that business. This evaluation will include reviews of necessary information to consider whether or not to make the investment.
Types of Due Diligence

Investors will have their own assumptions and criteria to decide whether a business is suitable for their investment purpose or not. Depending on the investment purpose, businesses will have to undertake several Due Diligence activities, either voluntarily or as an obligation.

Based on the conditions, investors can request businesses to conduct Due Diligence in various ways, most commonly in the forms of Financial Due Diligence, Commercial Due Diligence, and Legal Due Diligence. In addition, a number of other aspects can also be reviewed such as Tax Due diligence, IT Due Diligence), Intellectual Property Due Diligence.

Administrative Due Diligence 

Administrative Due Diligence or administrative management appraisal is an investigation involved in verifying facilities, infrastructure, etc. The purpose of this Due Diligence is to verify whether all operating expenses are captured in finance or not. Administrative Due Diligence also gives an overview of the type of operational expenses that buyers may incur if they plan to pursue the expansion of the target company.

Financial Due Diligence 

One of the most important Due Diligence types is Financial Due Diligence. This activity seeks to verify if the financial representations in the confidential information are correct. Financial Due Diligence aims to provide a thorough understanding of the company's finances, including but not limited to audited financial statements over the years, company forecasts and forecast basis, capital expenditure plan, inventory schedule, debtor and creditors, etc.

Financial Due Diligence process also includes analysis of key client accounts, fixed and variable costs, profitability analysis and internal control procedures audits. Furthermore, it checks the company's order books and sales pipeline to generate more accurate forecasts. Many investors normally have a separate financial analysis focusing on the debt situation of the target company, assessing both short- and long-term debt, applicable interest rates, the company's ability to handle outstanding debts and financial security if needed, along with an overall check and assessment of the company's capital structure.

Types of Due Diligence

Asset Due Diligence

This is a kind of Due Diligence on property. Asset Due Diligence reports usually include a detailed schedule of fixed assets and their locations (if possible, actual verification should be required), all equipment rental agreements, sales and purchase schedules of large capital equipment in the last five years including real estate, mortgages, ownership policies and licenses.

Human Resources Due Diligence

Human Resources Due Diligence is a fairly wide-ranging activity, which can include all of the following: analysis of the total number of employees, including current position, vacancy, working time, etc., analysis of current salaries, bonuses, etc., all labor contracts with the terms of non-disclosure, no solicitation, no competition between the company and its employees, etc. In the event that there are a few irregularities related to general contracts, any questions or issues need clarification. 

The personnel policies relating to annual leave, sick leave and other types of leave are also considered. Employee matters, such as allegations, disputes, litigation, discrimination and any pending legal cases with current or former employees are reviewed as well. 

Environmental Due Diligence

Environmental Due Diligence is very important because if the company violates any of the laws, local authorities can exercise the right to sanction the company. Therefore, this makes Environmental Due Diligence with each property owned or leased by the company become one the most important due diligence types. 

What are included in Environmental Due Diligence? They are the list of environmental licenses and certifications, copies of all correspondence and notices of the State and local regulatory agencies, verifying that the company's handling practices are consistent with applicable regulations and instructions, etc.

Taxes Due Diligence

Tax Due Diligence includes reviewing all taxes that the company has to pay. In addition, it also covers the verification of the status of any pending tax with the tax authorities. Documents about tax compliance and potential issues often include verification and review of the following: copies of all tax returns - including income taxes, deductions and sales taxes; information regarding any past or pending corporate tax audit; documents relating to any unused credit made under deductions or tax credits; any important, unusual correspondence with the tax office.

Intellectual Property Due Diligence

Almost every company has intellectual property that can be used to make money. These intangible assets are something different from their products or services. They can often include some of the company's most valuable assets. 

So, what are there in Intellectual Property Due Diligence? They are: patent schedule and patent application; copyright, trademarks and brand names; patent pending; any claims pending or against the company regarding intellectual property infringement.

Legal Due Diligence

Legal Due Diligence is extremely important and often involves examining and considering the following: a copy of the memorandum and terms of legal associations; minutes of the Board meeting over the past few years; minutes of all meetings and actions of shareholders over a number of years; a copy of the stock certificate issued to the main manager; copies of all warranties to which the company is a party; all physical contracts, including any joint venture or cooperation agreements, limited liability companies or operating agreements; license agreement or franchise; copies of all loan, financial and banking agreements and credit limits to which the company is a party.

Customer DD 

Because customers are the lifeblood of any business, Due Diligence always includes a close look at the target company's customer base, with the checks and analysis on the company’s leading customers, service and corresponding insurance agreement, customer satisfaction and related reports, list with explanation of any lost major customers.

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Due Diligence: What you need to know

Henry Tran - VietnamCredit

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