TM 1 - M&a - Corporate Due Diligence

Corporate Due Diligence for Business Combinations
FT MBA - Trim VI Teaching Material

Mergers & Acquisition
1
Dr. Paritosh Basu
Acknowledgement
The author acknowledges that freely available graphics through internet
have been used for this presentation with the objective of propagating
knowledge
Corporate Due Diligence - Business Combinations

Operational and Financial Due Diligence
Large Deals and Transactions
Merger - Entities, Business Groups
Acquisition Entity, Division, Business Group, CGU, Set of
Assets
Demerger
Investment IPO, Equity, Quasi Equity, Long Term Debt
Repetitive large transactions Precursor to a prospective Deal
Long Term Procurement / Supply Arrangement
Anciliarisation
Wet-Leasing
s
Other Due Diligence Services
ei t
c
n
ige eigh
l
Technological
i
D
-w
Human Resource
Supply Chain / Logistics
Legal
Strategic Alliance
Commercial
r
e
Du unte he t
o o t en
t
ac
m gers
e
t
i
a
exc man ursue
e n to p t
h
w
gin targe
e
b
a
Big Questions ??
re
e
h
t ax
Is
y T age
n
a
nt
a
v
?
Ad
What
synergies
do we see
with the
target?
Wh
com at
adva petitive
ntag
we g es do
et ?
l.
n
g
r ng
O
i
l
l
Wi uctur d?
tr ede
s
e
r
n e at
e
b Wh s if
en y
p
p
e
ha e k ve?
somle lea
op
e
p
What is
our walk
away
price?
What is
the
target
control
premium
we pay?
Is the
r
techn e any
ol o
advan gical
tage?
re
Is the
any
ti v e
a
c
i
d
in
om
r
f
e
c
pri
rs?
Othe
ce
a
f
w e r al
l
l
Sha cultu
any ange nt
ch eme
nag es ?
a
m
issu
Is there any
competitive
synergy with
target?
What is
the right
time to
close the
deal?
Do we
know
what are
we
buying?
4
Organisational realities to be identified and managed post

the deal from BPM perspective
g
F u n c tnino n a l R e s t r u c t u r i n g
o
i
t
Revitalising
i
s
o
g
p
n
i
e
s
i
r
R
Downsizing
a
l
i
Cross-functional Multitasking
c
n
A
Timesizing
Rightsizing
Change Management Needs
Re
-en
gin
e
er
ing
Delayering
Synergy Maximisation
Brightsizing
Source: faculty.css.edu/dswenson/web/Powerpoints/ChangeDrivers.ppt
DD to Assess Nine Elements of Organisational Health
https://www.linkedin.com/topic/m%26a-due-diligence
Deal Making is glamorous, due diligence is not
Due Diligence is neither a pure science not an art. It is

a combination of both. It also demand lots of sixth
sense and professional intellect.
About of half of deals fail to deliver the expected results

The most important need for
success in M&A are
What objectives are to be
achieved Scale or Scope
What are the hidden upside
or down side effects
DD capabilities
Total discipline at each
stage of the deal value
chain
Discover what is not known
about target
Not relying on the target for
intelligence
What will be the effects on
existing business
8
What the Experts Opine about

Mitigating Risks through Financial Due
Diligence
Mitigating Risks While Doing Diligence Financial Due
Diligence
https://www.youtube.com/watch?v=ysKvSx_SINk
man aspects of financial due diligence
p://www.bain.com/publications/articles/human-due-diligence-video.aspx
Corporate Due Diligence is also about detecting the

skeletons in the cupboards of the target company
One of the tasks for detecting skeletons is to strip away all accounting
idiosyncrasies
10
Illustrative Check List for Corporate Due Diligence
11
12
http://www.eperinc.com/mergers-and-acquisitions-ma-environmental-due-diligence/
Two Stages of Corporate Due Diligence

Exploratory analyses to assess Potentials to generate return in a given
time frame
Due diligence is a rigorous process that finally determines whether or
not the DEAL will go through. The process involves
Asking and answering a series of questions to evaluate all the
aspects of the entity and the opportunity
Rigorous review and scrutiny of a large number documents past
periods financial statements and projections;
Quantitative and qualitative review of synergies and integration
Qualitative review of managerial personnel and leadership team
Finding misrepresentations in the document of the prospective

investee
The process is of two stages
Initial Screening - Whether the proposal fits the funds mandate or

criteria, e.g., the business stage, geographic region, deal size,
industry sector.
Detailed DD
13
Initial Screening Questions

Quick Litmus Test questions for initial screening
Exact nature of business, product / service What is Unique?
Product potential
Possible areas of synergies and competitive advantages
Possible Intangible Assets not accounted for in Books of Accounts
Reasons of failure vis--vis previous suitors, if any
Post deal fund requirement and subsequent tranches if any
Board value settlement strategy expected by acquiree
Present location of business and plan for expansion in new areas
Broad operating plans and expansion
Technology Stage Uniqueness, horizon of substitution
Product / service life cycle
14
15
Perspectives of FS Analyses for Broader Understanding

In-depth Study of Operations, Profitability and Financial State of Affairs
Deeper Understanding
Business
SWOT - Raise
post deal Returns
Enhanced
Credibility
of DD as
An exercise
Risk Analysis
DD as a Tool
for Deal
Negotiation
16
Desk Top Financial Due Diligence

(With or Without Internal Inputs)
Futuristic
Analysis
Post Facto
Business
Combinations
Financial Due Diligence
LT Arrangements with
Customers & Suppliers
Contingent Liabilities and Commitments
Investment
in Equity
Off - Balance
Sheet Funds
17
Strategic Due Diligence for Introspective Analysis
Essential for Deal Closure
18
Source: http://www.bain.com/bainweb/media/flash/popup_funnel_chart.asp
Analytical Due Diligence

Bridging the Gaps in Understanding about the Target
19
Review & Analyses -
Business Plan, Earnings Guidance and FSs
1. Product pipeline - Quantitative Growth Analysis of past and

future with impacts of new products if any
2. Customer Contracts - Onerous or probability to turn onerous to
profitable, volume commitments if deal is for backward
integration
3. Supply Chain Arrangements for both Inputs and Outputs Scope to rescind if tending to be loosing proposition - Price,
Logistics, Product , Input and / or service availability
4. Existing Intra-group contracts - Need for Father-hooding /
closure
5. Operating Profitability Identify any infected limb
6. Arresting down trend in Gross Margin - Efficacy of concrete
remedial measures initiated or to be initiated post the deal
7. Order book (Construction Cos.) - With or without escalation
8. Trends in Prices - Inputs and Outputs
9. Inflation Adjustment - Success factor in passing cost increases
to customers - Industry trend
10. Objectives of Transaction for DD - Specific issues to be
20
Review & Analyses BP, EG and FSs 2

11. Nice, Essential & Must (NEM) - Outcomes from Analyses of
Expenses
12. SWOT Leadership team view points revealed in MD&A
Section
13. Capital Expenditure - Maintenance / Sustenance and
Expansion
14. Projects in hand - Status for expansion, diversification, etc.
15. Market, Customer and Vendor - Major changes if any
16. Working Capital Model - Going Concern with our without fresh
injection of short term funds
17. Projected FS - IS, BS, CFS in comparison to previous years
after eliminating extra ordinary impacts; Past instances of
failures in guidance - Earnings and Capital Expenditure to market
18. Cash Flow Forecasts - FCF, Term Loans, Quasi Equity

Conversion with optional / compulsive commitment for
Dilution
19. Sensitivity Analyses - for projected IS CF and BS
21
Review of BP, EG and FSs
21. Commitments and Insurance Contracts - Impacts on future

performance
22. Employee Benefits Defined Benefits and / or Contribution
23. Statutory Audit Report Immediate and long term financial
impacts of
(a) Qualifications
(b) Drawing Attention / Matter of Emphasis Paragraphs
(c) Qualifications in CARO Value, Systems, Compliance, Failures
24. Corporate & Brand Images - Respect amongst industry peers

25. Sustainability Management 4P Approach
26. Status of Corporate Governance
27. Corporate Social Responsibilities
28. Regulations - Effects of any regulatory provisions on the anvil
29. Second Tier Focus Areas of DD Specific areas of focus and in
depth analysis second tier review
22
Review of BP, EG and FSs
A typical method for projecting each of General & Administration Expenses

Last years actual expenses
Minus
Expenses for last years one time activities
Minus
Targeted reduction from normal expenses
Minus
Reduction arising out of planned discontinuation of old operations
Plus
Expenses for new activities contemplated for the budget year
Plus
Expenses for the budget years one time activities
Plus/ Minus
Inflationary adjustment
Plus/ Minus
Increase/ decrease due to statutory provisions
Plus/ Minus
Increase/ decrease due to changes in regulatory provisions
Equal to Next periods projected expense
Note: Certain expenses originate from oganisational culture and
legacies Specific review is needed to understand whether those will
23
continue.
Review of BP, EG and FSs 5

Exploratory analyses for assessing ability to ensure sustainable growth
What are the plans, action points, capital and revenue

expenditure for
Reducing material intensity
Utility audit and reducing consumption of power, fuel,
steam, water, etc.
Optimisation and substitution of raw natural resources
Minimising dispersion of toxic substances
Green logistics for renewable and used products
Recycling of scrap, wastage and spoilage
Prolonging product life at minimum differential price
Increasing service intensity to reduce frequency
CXOs to ensure viability and growth after absorbing all these expenditure
Similar points are also to explored for vendors
24
Quality of Historical Earnings, Assets & Liabilities

(If possible, with enquiries Industry Research reports and internal inputs)
1. Understand the revenue streams from MD&A and contemporary

and foreseeable business ecosystem
a.
b.
c.
d.
Business Segment (CGU)

Product(s) Volume, Price, Customer Segment
Geography Domestic and Overseas (Country-wise)
Competition, Regulatory changes, Coupling effects, etc.
2. Historical trends in pricing and gross margins

3. Business Model Revenue Generation, Growth & Expansion,
Capital Structuring
4. Post sales events Trends in
a. Sales Returns
b. Rework, Warranty and Customer Loyalty obligations
c. Provision for Doubtful Debts and write-off
5.
6.
7.
8.
Exceptional non recurring items

Write-off / impairment Receivables, FA, Investments
Review product profitability trends covering 80 % of turnover
Pricing pressures Competition, Materials and Conversion Costs
25
Quality of Historical Earnings, Assets & Liabilities 2

9. Sustainability of margins and recoverability of dues
10. Impact of changes in
Key accounting policies
Methodologies for measurement; affecting
i.
ii.
iii.
iv.
v.
vi.
vii.
Accrual of Income
Depreciation
Fixed Assets, Intangible Assets and Goodwill
Debtors provisioning,
Inventory Valuation,
Capitalisation
Valuation of Assets
11. Impact of material changes in financing arrangements and of

any other profitability adjustments on Net Worth / Net Assets
12. Charges created on various assets Terms and conditions
13. Reconciliation of Profit as per IS and Tax Records
14. Status of Tax Assessments
Availability of tax losses and other tax benefits / exposures
Implications of tax liabilities and disputed demands
Impacts of pending disputes at various levels of judiciary
26
27
Your Questions?
28

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What are the different types of due diligence discussed?

What are the different types of due diligence discussed?

What are some of the important aspects of financial due diligence?

What are some of the important aspects of financial due diligence?

Corporate Due Diligence for Business Combinations

FT MBA - Trim VI Teaching Material

Corporate Due Diligence - Business Combinations

Supply Chain / Logistics

Organisational realities to be identified and managed post

DD to Assess Nine Elements of Organisational Health

Deal Making is glamorous, due diligence is not

Due Diligence is neither a pure science not an art. It is

About of half of deals fail to deliver the expected results

What the Experts Opine about

man aspects of financial due diligence

Corporate Due Diligence is also about detecting the

Illustrative Check List for Corporate Due Diligence

Two Stages of Corporate Due Diligence

Qualitative review of managerial personnel and leadership team

Finding misrepresentations in the document of the prospective

The process is of two stages

Initial Screening - Whether the proposal fits the funds mandate or

Initial Screening Questions

Possible areas of synergies and competitive advantages

Possible Intangible Assets not accounted for in Books of Accounts

Reasons of failure vis--vis previous suitors, if any

Post deal fund requirement and subsequent tranches if any

Board value settlement strategy expected by acquiree

Present location of business and plan for expansion in new areas

Broad operating plans and expansion

Technology Stage Uniqueness, horizon of substitution

Product / service life cycle

Perspectives of FS Analyses for Broader Understanding

Desk Top Financial Due Diligence

Financial Due Diligence

Strategic Due Diligence for Introspective Analysis

Essential for Deal Closure

Analytical Due Diligence

Review & Analyses -

Business Plan, Earnings Guidance and FSs

1. Product pipeline - Quantitative Growth Analysis of past and

Review & Analyses BP, EG and FSs 2

18. Cash Flow Forecasts - FCF, Term Loans, Quasi Equity

Review of BP, EG and FSs

21. Commitments and Insurance Contracts - Impacts on future

24. Corporate & Brand Images - Respect amongst industry peers

Review of BP, EG and FSs

A typical method for projecting each of General & Administration Expenses

Review of BP, EG and FSs 5

What are the plans, action points, capital and revenue

Similar points are also to explored for vendors

Quality of Historical Earnings, Assets & Liabilities

1. Understand the revenue streams from MD&A and contemporary

Business Segment (CGU)

2. Historical trends in pricing and gross margins

Exceptional non recurring items

Quality of Historical Earnings, Assets & Liabilities 2

11. Impact of material changes in financing arrangements and of