Due Diligence: Preface
Just because the term is broadly used across various disciplines, the meaning of due diligence doesn’t change. In one word – due diligence connotes “investigation”. In the context of business, it refers to the investigation done by an interested party, including venture capital and private equity firms, into a merger or acquisition target or to inspect companies for potential investments. It helps a buyer organization to evaluate the economic health and performance of the seller company by illustrating the company competencies, the target market, potential customers and profit-making capabilities before moving ahead with the offer proposed. In layman’s terms conducting due diligence is like doing “research work” on a potential deal to keep the unpleasant surprises at bay in the future. This homework today is crucial to making informed investment decisions tomorrow. Because prevention is always better than cure!
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Due Diligence: Objectives
Mistakes are sure to occur when you are doing huge transactions in your business. Even a tiny mistake can lead to big troubles when you are in a business especially in the UAE. Whether a new supplier, a partner in a transaction or an acquisition target, third party relationships not just produce opportunities but risks too. And financial and reputational costs can be significant if something goes wrong. Therefore, the management should take special care not to make any mistakes. But how? Due diligence audit is the answer. And the purpose is as clear as day. Due diligence audit is conducted to:
- Steer clear of a bad business transaction
- Corroborate the transaction whether it adheres to investment or acquisition criteria
- Ascertain the risks and opportunities that comes with a proposed transaction
- Slash the risk of post-transaction disagreeable surprises
- Vet the business affairs as a vigilant business owner
- Bear out all material facts associated with the business
- Verify the too-good-to-be-true deals
- Ensure that the business is what it appears to be
- Foster trust between two independent parties
Due Diligence: Benefits
While a typical audit seeks only to provide an opinion on whether the past financial statements represent a ‘true and fair’ view of the company’s operations, financial due diligence is way beyond bringing myriad advantages to the management and ownership. Not only does the financial due diligence auditor dig into the historical financial performance of the company but the forecast financial performance and its viability under the current business plan as well for the company. Plus, the reasons for any trends noticed in the results of the target company over an appropriate time period are also studied to notify the company about the applicability of the same to the proposed transaction. Not only that but depending upon the scope of the work undertaken a financial due diligence audit:
- Betters the business status.
- Helps unveil any invisible information about the business.
- Functions as a risk appraisal tool for a business.
- Let’s buyers make informed decisions and sidestep surprises at the end of a deal.
- Empowers buyers in ‘caveat emptor’ while ensuring that they are free from defects and fit for purpose.
- Vouches that the buyers ‘get what they pay for’.
- Confirms whether the information provided by the target/seller is reliable.
- Tells if the historical earnings of the target company are sustainable.
- Helps figure out potential future earnings of the target company
- Informs about the possible synergies associated with the proposed acquisition.
- Enlightens about immediate and future tax consequences of the proposed acquisition.
- Informs whether the purchase price is fair (given the results of the due diligence process).
- Conveys about any potential deal breakers (based on the outcome of the due diligence).
- Mentions whether the proposed structure of the acquisition is appropriate.
- Guides the company on including any warranties and guarantees in the legal documentation.
Due Diligence: Types
Due diligence is used majorly in the legal and corporate realms. You might come across four types of due diligence audit in UAE relevant for your business:
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