Due diligence

Jan, 05 2024


Due diligence procedure is one of the tasks of a comprehensive study of business: an audit in the course of due diligence helps to strengthen relationships for a large-scale transaction between counterparties. Also due diligence, as a rule, is applied in the case of the acquisition of a business or any large objects (for example, land or real estate).

When concluding a deal, due diligence helps to assess risks and obtain high-quality protection of the interests of the parties.

In this case, it is impossible to do without a comprehensive solution to the issue, which will directly depend on the qualities and characteristics of the acquired objects. Legal due diligence and economic justification are the minimum of those relationships that are studied during this process.

Why is the procedure needed?

Term and meaning due diligence came into legal circulation in America at the beginning of the 20th century – and initially meant the procedure for the broker to publish data about a company and its shares on the stock market to an investor on the stock exchange.

To date, holding due diligence in a company means collecting and analyzing information for a comprehensive assessment of the various risks that may relate to the investment process. Thanks to due diligence provides collection of objective data and expert evaluation of the information received about the object due diligence.

And such a procedure is largely aimed at verifying the legality of the activities of the investment object, as well as the commercial attractiveness of a potential transaction, relating to the areas of accounting, personnel, and tax accounting.

Practical use of the procedure

Conducting such an analysis is carried out for the initial stage of the transaction, namely:

  • Business merger or divestment process
  • Purchase and sale of shares, including a share in a business
  • Acquisition of real estate
  • Connecting to business partners
  • Lending and lending
  • Implementation of targeted investment as sponsorship or on a gratuitous basis
  • Financial transactions that require reliable information both about the object of the contract (including the company in relation to which the financing is being carried out) and about the investment project

Types of procedure

It is customary to single out several types of this procedure, and depending on the object of analysis due diligence can be :

  1. Technical, or technical, which consists in checking documentation (including design, technical, and even budget). If we are talking about construction projects, then here due diligence is usually applied to utilities.
  2. Ecological, or environment , in the process of which monitoring of compliance with the system of use of natural resources (land, water, air, etc.) that make up the surrounding space is carried out.
  3. Marketing, or marketing , ­which is associated with the study of a system of methods due to the coordination of the production process with respect to the economic situation and guaranteeing a stable turnover of products. Such an analysis can also apply to the study of product and pricing policies, and even personnel management systems.
  4. Economic, or economical , which is directly related to the material aspects of the business, i.e. the state of its economic and property part, as well as its position in the financial sphere.
  5. Tax, or fiscal , usually part of the economic procedure, and related to financial due diligence .                                 
  6. Legal, or legal due diligence , in which an assessment is carried out by the legal activities of the company; similar form of legal due diligence is aimed at identifying existing or possible risks of deprivation of assets.
  7. Financial, or financial , which provides verification of the reliability of financial information about the results of the company’s management; this form of financial due diligence is, simply put, an assessment of prospects.

If we talk about the classification of this process, then, first of all, it concerns the characteristics of the due object itself.diligence , and in this respect it is customary to highlight the analysis of the following assets:

  • intellectual property
  • real estate
  • corporate entities (holdings, trusts and other quasi-corporate systems)

This type of classification is usually used in English-language sources, and in general makes it possible to emphasize the complex nature of the process.

Who performs the procedure

Today, the customer of this procedure can be not only a commercial banking institution, as it was before, but also an investor (who directly makes the final decision on investments), or a company carrying out an acquisition, when assessing risks. due procedure diligence can also be ordered by the counterparty itself when making a decision to attract investments.

The time it takes for the due procedure diligence

The duration of the procedure depends on the size of the business that is being audited – and can last from a few weeks to 12 months. Such a comprehensive and thorough analysis of the situation will provide an opportunity to avoid the risks that may inevitably arise when concluding a serious contract (for example, the sale and purchase of a company or its share).

Report on the results of the procedure

After the process of studying and studying the entire amount of information based on the results of the check, a report is drawn up regarding the progress of the procedure.

Professionals of several directions take part in the procedure itself:

  • lawyers for legal due diligence ,
  • appraisers,
  • auditors.

Accordingly, at the end of the process, three reports are provided – and, as a rule, all significant information is combined into one presentation.

Such a presentation of the results of the activities of specialists who worked in a team allows the investor to make a balanced and informed decision, focusing on the main points.

The report, in accordance with the requirements of federal law, is drawn up in writing, based on established standards, which necessarily include the following structure of this document:

  • introduction,
  • legal due diligence diligence ,
  • risks,
  • conclusions.

Stages due diligence

Today, for all parties of economic relations, the need to manage all possible risks in the implementation of activities is becoming increasingly important, which ensures the improvement of the financial management process and the formation of a correct investment policy.

And the requirements for transparency in the organization of activities are no longer a trend, but refer to mandatory conditions – in view of the formation of a new direction in the relationship of counterparties, and the need to modernize the production process, as well as investment relations (taking into account entering the international market). At the same time, this requirement6 may apply not only to the leading market players, but also to developing and only gaining momentum companies.

You need to understand that usually the due process Diligence is carried out by joint efforts in several directions:

  • Financial analytics, or financial due diligence , which takes into account:
  • analysis of indicators in the financial sector, including development prospects,
  • dynamics of financial indicators,
  • capital, rights and obligations that are supposed to be alienated,
  • the condition of the fixed assets in terms of suitability, depreciation and need for renewal, as well as the prospects for the disposal of funds that are not needed.
  • analysis of financial turnover and business schemes, the circle of counterparties, as well as the results of activities that are directly related to the formation of financial indicators.
  • auditors whose task is to conduct a financial analysis of business activities, which includes:
  • study of the structure of business income and expenses for a certain reporting period, including also the main financial indicators for the company,
  • analysis of the internal control procedure regarding document flow in the part related to business expenses, as well as selective review of the quality and integrity of documentation that confirms expenses,
  • valuation of fixed assets, including depreciation, total composition and revaluation,
  • analysis of investment investments,
  • assessment of receivables,
  • analysis of the company’s reserves, including their composition, development dynamics and cost,
  • study of accounts payable,
  • study of obligations of a conditional type, including fines, guarantees, bills of exchange, claims, pledges and other encumbrances regarding the property of the enterprise.
  • consideration of the completeness of accounting (including its reliability) in relation to assets and other liabilities that are reflected in the company’s balance sheet,
  • identification and systematization of all existing tax risks, potential or simply unaccounted for business tax liabilities
  • Lawyers providing legal due diligence , provide verification and analysis of rights and obligations in the field of:
  • property that is sold during the sale of the enterprise, including the risks of third parties contesting the rights to this property,
  • the existence of rights and obligations, their legitimacy, the risks of contesting contracts, as a result of which these rights and obligations were formed,
  • labor relations, regarding the team that currently exists in the company: labor agreements, liability contracts, the risks of presentation of property claims by dismissed employees, and the legitimacy of dismissed employees.
  • compliance with the requirements of corporate legislation in relation to all areas of the company’s activities, as well as the related risks of claims from the participants of the companies due to non-compliance with the law when selling their share, or other large-scale transactions.

The essence of legal due diligence consists in a thorough study of the whole complex of relationships – both within the organization and in its interaction with the surrounding business environment where the company operates.

Conventionally, such a study can be divided into certain blocks, which differ both in goals and in the methodology used, but provide a comprehensive analysis of the company’s activities, without fail including its financial condition.

These blocks usually include:

  • Operational review (including the organization of activities) and analysis, which includes the historical development of the business, its organizational structure, staff composition, factors constraining development, as well as negative and positive aspects of the activity,
  • Financial study – with a mandatory conclusion on the ability of the enterprise to provide profit,
  • Study of the tax situation of the company for a comprehensive study of the tax burden of the business and moments of tax optimization.
  • Legal expertise, which provides an analysis of the company’s activities in relation to the current legislation and acts in the field of various areas of application of law – from civil to corporate.
  • Consideration of the state of the company in relation to the market in order to establish the place of business in a competitive environment – first of all, the potential and availability of development prospects, including an analysis of development opportunities, based on the current market dynamics.
  • A study of the impact of business on the environment, primarily regarding the impact of the company on nature and its resources.

Naturally, such a check does not necessarily have to be carried out in full: a sufficient level and the need for analysis is determined, first of all, by the purpose of such a study.

The due diligence process is an important step in preparing for a major deal , and it must be taken into account that the negative effects that a business may face in the absence of such an analysis can be much greater than the costs of such a due diligence.

Author of the article
Due diligence
Valentina Khlavich
Managing Partner
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