INTRODUCTION
Due Diligence is the investigation process for relevant facts and financial information undertaken by professionals of different fields to ensure that the organization is running smoothly and efficiently without any default. The main purpose of due diligence is to give confidence to the acquirer company that the company is in good condition and they will not face any such difficulty after acquiring the company. It shows the company plans to raise additional capital. It covers both inter- corporate as well as intra- corporate transactions along with the regulatory checklists. The cost of the due diligence depends on the effort and scope of the kind of diligence undertaken.
ROLE OF DUE DILIGENCE IN M&A TRANSACTIONS
The role of legal due- diligence is to check whether the company has complied with all the relevant laws or not. The relevant laws applicable to companies are:-
2) SEBI Act, 1992
3) Labour laws
4) SARFAESI Act
5) Prevention of Corruption Act
6) Prevention of Money-laundering Act
7) Real Estate Regulations Act
8) Indian Trust Act, 1882
9) Transfer of Property Act,1882
It depends on the company-to-company basis under which laws they are being regulated. The benefits of this type of due diligence are four-fold for the acquiring company. First, it enables the buyer to understand the target company and its operations. This then aids the buyer in not only determining a fair purchase price but helps to prepare a strong M&A contract. And most importantly, with a thorough understanding of the target’s potential legal risks and liabilities, you can make an informed decision and avoid falling into hot water later down the track. After the due – diligence is approved by the professional Entrepreneurs and start-up founders are not the kind of people who would be extremely adept with paperwork and are often clueless about the documentation required at the time of seeking investment for their stunning business idea. A term sheet happens to be the preliminary document that a start-up founder has to encounter at the beginning of any investment transaction. In simple terms, a term sheet is like a marriage proposal where the company and the investor meet to negotiate the terms of their investment. Basically, a term sheet is a legal document that sets out the parameters to be adhered to by parties in a business agreement. It is a document that marks the start of an investment transaction.
Some of the important clauses which parties need to be well-versed with are as follows:-
1) Investment Amount – The amount that is being invested in the company. This clause is important from the company’s stand view to raise capital.
2) Pre-Money valuation – Companies are valued by investors through various modes such as Asset based model, Market Valuable model, Discount Cash flow model and others.
3) Conversion right – This is quite a favorable option for early investors whose ultimate objective is to gain equity control in the company.
4) Liquidation Preference – LP sets out who gets paid. Firstly how much they get in the event of an IPO or winding up or investors needs to strategically exit the Company. It is said to be downside protection clauses and means to protect investors from adverse consequences of downside events at a valuation lower than investors entry valuation.
5) Anti- Dilution clause – Investors have an apprehension that their own shareholding may gets diluted in came Company go ahead with new shares. For this purpose the investor insists on “Anti-dilution clause “. It is achieved by having adjustment formula through which Investors original shareholding is arrived at.
Now, let us start answering questions that arises out of the discussion in a term sheet.
A. When does a term sheet need to be signed?
Term sheets are not time-specific but they are pre-financial documents. They are precursors to any final agreement like an SHA, SPA or SSA. They are the basis on which these documents are executed. Hence, as far as the signing of the term sheets is concerned, that will occur once both parties agree to the terms of the term sheet and before the financial agreements like SHA, SPA or SSA are executed.
B. Who usually prepares the term sheet?
A term sheet is usually prepared by the investors after the pitch of the entrepreneur to such investors. That being said, there is no hard and fast rule regarding who can prepare the term sheet first. Logically, the investors after listening to the pitch of the entrepreneurs prepare the term sheet which then goes on for a number of rounds of negotiations.
TYPES OF DUE DILIGENCE
1) legal due diligence – This means that there are no legal issues in buying a business or investing in it. The solicitors will review important documents such as board resolution, AOA, MOA, employment contracts
2) Operational due diligence – In ODD the potential purchaser reviews the operational aspects of the target company during M&A.
3) Tax Due-diligence – They aimed at ensuring that there are no tax liabilities in the seller firm that have materialized due to mistake or deception and could not hold the acquirer liable for it.
4) Intellectual Property Due Diligence – It aims at establishing what rights the company will have in various intellectual properties. Such intellectual property will include copyrights, patents etc.
CONCLUSION
Due diligence is a crucial step in mergers and acquisitions because an M&A deal can be a complex and expensive process. The investor, their consultants and accountants, must perform extensive due diligence to protect them from unexpected risks. Additionally, the target company must be ready for these due diligence tasks and make sure that everything goes smoothly and provide all relevant documents, efficiently, and in the best interests of all parties involved in the transaction.
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