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How We Conduct Due-diligence

Our Due Diligence (DD) Team members include lawyers, accountants, technical personnel and business advisers. 

A detailed DD guidelines is made available to clients prior actual due diligence is carried out. However, a brief outline is provided below:

The following are carefully reviewed:

  1. income statements
  2. records of accounts receivable and payable
  3. balance sheets and tax returns including business activity statements (last 3-5 years)
  4. profit and loss records (last 2-3 years)
  5. cash deposit and payment records, as reconciled with the accounts
  6. utility accounts
  7. bank loans and lines or letters of credit
  8. minutes of directors' meetings/management meetings
  9. audit work paper files (if available)
  10. the seller's claims about their business (e.g. their reasons for seeking investments, the business's reputation, etc.)
  11. privacy details (e.g. of employees, trading partners, customers)
  12. stock
  13. details about plant, equipment, fixtures, vehicles (are they in good working order and licensed?)
  14. intellectual assets of the business (e.g. intellectual property, trademarks, patents)
  15. existing contracts with clients/staff
  16. partnership agreements
  17. lease arrangements
  18. details of the business's automated financial systems
  19. details of credit and historical searches related to the business.

Warning signs for the Investor

Our Due diligence team is wary of businesses who:

  1. do not disclose important information (e.g. their reasons for seeking additional investments, financial statements, licences and permits, staff contracts)
  2. won't agree to a trial period or enough time to conduct due diligence (DD team will need at least 30 days)
  3. won't introduce to their suppliers, landlord or estate agent
  4. are involved in legal proceedings
  5. are keen to close the deal quickly
  6. have a questionable credit record and history.

The business
  1. Is the type and size of business compatible with your interests, experience, personality and capital?
  2. Is the business part of a group or franchise that may restrict how it operates?
  3. Does the place of business have all the required permissions to perform the business functions it does? Town planning laws and work health and safety regulations are particularly important here.
  4. Are there any procedure manuals or quality assurance programs in place?
  5. Are new licences required? Licences may include licences for equipment and user licences.
  6. What is the real reason why the business is for sale or seeking investment?
  7. Is the seller/owner being cooperative and supplying all relevant information?
  8. Is the seller/owner willing to sign an agreement to refrain from competing against you (i.e. restrictive covenant)? Legal advice is usually necessary here.
  9. Will the seller train and help you after you buy? If so, for how long?
  10. Is the seller's personal role critical to success?
  11. Does the buyer/investor have similar skills, experience and personality to the seller if it is their role you'll be replacing?
  12. Would there be an opportunity to work in the business for a trial period before entering into a contract?
  13. Is the personality of the seller/owner a factor critical to the business's success to date?
  14. What role does the seller/owner play in the day-to-day running of the business and would they be missed?

Competition
  1. Are prices competitive for the nature of the business?
  2. Are competitors gaining strength?
  3. Will the internet mean price-based competition from countries with lower costs?

Industry
  1. Is the industry in which the business operates expanding, contracting or remaining static?
  2. Is any deregulation likely to occur in this industry that may open the business to greater competition than it experiences now?
  3. How does the business rank against other businesses in the same sector?

Suppliers
  1. Will you be able to continue buying the products from existing suppliers?
  2. Have any suppliers been offering special conditions to the seller based on unwritten agreements?
  3. Have you checked the business's credit rating with suppliers? Will you receive an established rating or be treated as a new account?

Location
  1. Is the business in a good location or is this the reason why it is for sale?
  2. Are new developments going to be commenced or opened in a nearby location that could affect your trade?
  3. Are there any impending town planning changes that may affect the business?
  4. Are major road developments or public works going to proceed in the near future that may affect your business?
  5. Has a rezoning application been lodged in regard to either the intended business location or nearby locations?

Lease
  1. Is there a rental lease in place? Can you continue under the current lease or do you need to establish a new one?
  2. Have you checked the terms and conditions of any lease of premises and discussed these with your solicitor?
  3. Has the landlord changed recently? This could indicate matters such as an impending increase in lease payments or possible redevelopment proposals.

Staff
  1. Are there any contracts in place with staff?
  2. Are remuneration packages for staff clearly defined?
  3. Are staff paid the correct awards and wages, and do they expect wage increases soon?
  4. Which party is responsible for previously accrued entitlements to long service leave, holiday pay, sick leave, superannuation and other employee benefits?
  5. Has workers' compensation insurance been paid in respect of all employees?
  6. Do current staff require any licences? 
  7. Is it possible to talk to staff privately and interview staff members without management interference before sale?
  8. Is an adequate salary allowed for work done by the owner and their family in addition to an adequate profit margin?

Legal
The following are thoroughly checked: 

  1. What are the terms and conditions of any applicable lease agreement and the obligations and rights under such agreements?
  2. Are there any notices with regard to health, water and sewerage, environment or other government requirements that have been served on the business and require work to be carried out?
  3. Implications for the Investor of obligations under the intended business legal structure?
  4. Are there any legal proceedings pending against the business or the owners/promoters?
  5. Has the business sought legal and accounting advice on the best way to handle its finances, the purchases and their business structure?

Tax
Besides making sure that the target business is fully tax compliant, the following are also checked: 

  1. If an investor is buying an asset, at some point in the future he/she may wish to sell it. The relevant provisions of capital gains tax law must thus be looked into.
  2. There are special capital gains tax implications if investor sells/exits a business within 12 months of purchase. These must be considered.
  3. There may be transfer (stamp) duty implications while investing in business assets or if there's any internal trading entity restructuring (e.g. family partnership to company). These must be considered.
  4. Are there any GST or other tax implications for the investor


Financial records
  1. Analysis of the financial records for the past 3 years, including balance sheets, profit and loss statements, tax returns, purchases and sales records and bank statements. Have the records been well kept? Do they show potential for growth? What do the profitability and liquidity ratios show?
  2. Based on past financial results, the future cash flow and profitability of the business must be projected. Check what is the break-even point?

Accounts receivable
  1. Check for an aged listing of accounts receivable. Adequate provision for doubtful debts must be highlighted.
  2. Check if the business owner received any payments in advance (e.g. deposits) that they should reveal.
  3. Will the investor have to build up his/her own accounts receivable? Work out how this will affect cash flow once Investor has invested.
  4. Are accounts receivable sellable to a factoring agency (bank or finance company) in order to generate cash flow into the business? What would be the implications of such a move?


Sales patterns and records
  1. Are sales records reliable? Are the total sales broken down by product line?
  2. Are bad debts deducted from sales, or are they still shown as receivables? Is the percentage of bad debts within industry standards?
  3. What are the sales patterns year-by-year and month-by-month? Is the pattern seasonal or related to some business cycle (e.g. home construction or other uncontrollable variable)?
  4. Are there fluctuations in sales due to one-off sales?
  5. Are you sure all sales figures shown are for this business, and that the seller hasn't added sales from another business?

General sales information
  1. Is the product or service likely to maintain or improve its marketability or is it in danger of becoming over-sold, out of style or obsolete?
  2. Can you increase sales with current resources?
  3. What is the sales mix (the ratio of each product sold to total sales)?
  4. Can you achieve the required sales targets?
  5. Do you know the minimum and maximum likely sales?
  6. Is a particular salesperson critical to success? If so, will you be able to retain that person in your employment?
  7. Do a small percentage of clients represent a large percentage of sales?
  8. Is the seller continuing on with another business that may have some effect on the future sales of this business?
  9. What is unique about the business's product or service?

Expenses investigation

  1. Are the expenses disclosed include all expenses incurred by the business?
  2. Has the seller covered the business with the necessary  insurance cover?
  3. Have all compliance requirements (Work Health and Safety, Quality Assurance and Environmental compliance) been met and do they appear in the accounts?
  4. Beware of the add backs, which usually include personal expenses that had been charged to the business and have been credited back for the purposes of valuing the business.

Profits

  1. Take a hard look at the effect of increased or decreased sales on profit?
  2. Consider the effect of inflation on sales and costs in the years to come?
  3. Are profits adequate to warrant the risk of buying?

Warranties and refunds

  1. Are any goods/services on warranty? If so, should you make a financial allowance for possible warranty commitments?
  2. Will clients expect you to make refunds or warranties even in instances when you're not legally obliged to do so?

Conducting Due-diligence

In the investment world, due diligence needs to be performed by companies seeking to make acquisitions, by equity research analysts, by fund managers, broker-dealers, and of course by investors. For individual investors, doing due diligence on a security or asset is voluntary, but recommended. Broker-dealers, however, are legally obligated to conduct due diligence on a security before selling it. This prevents them from being held liable for non-disclosure of pertinent information.

Subcontracts India conducts due diligence on businesses for the purpose of Mergers & Acquisitions (M&A), outright sale or those seeking investments within India as well as from investors overseas. Any client falling into the aforementioned categories must first undergo our due diligence process. There is no exception to this rule. 

Conducting Due-diligence is a paid service and the costs vary depending on the size, location, type and spread of business involved. Starting at around US$60,000.00 (approx. Indian Rupees Forty Lakhs) the due diligence costs may reach as high as US$ 700,000.00. Clients are required to pay 50% of the DD costs at the time of signing a formal NCNDA/DD contract and the balance 50% of the costs at the point of submission of the final due-diligence report A client must unconditionally agree to undergo our due diligence process prior being allowed to meet our associated funders/financiers for investment pitching.


When investing in an established business it is vital that investors examine the target business in detail. This due diligence is generally conducted before a binding contract is signed.

Conducting due diligence is the best way for an investor to assess the value of a business and the risks associated with investing in it. Due diligence gives access to important and confidential information about a business, often within a time period specified in a letter of intent.

With this information the investor can assess the business's financial position and identify risks and ongoing potential. It is the investor’s chance to answer any questions the investor might have about the business. The due diligence process ensures that the investor gets good insight and value of an existing business. Done correctly, it can be the difference between investing in a business that makes or costs money to the investor.The due diligence team generally consists of lawyers, accountants, technical personnel, and business advisers for assessing aspects such as existing management practices, HR, Patents and R&D, market spread, strategic assets, etc. 

The main types of due diligence inquiry are as follows:

1. Administrative DD

Administrative DD is the aspect of due diligence that involves verifying admin-related items such as facilities, occupancy rate, number of workstations, etc. The idea of doing due diligence is to verify the various facilities owned or occupied by the seller and determine whether all operational costs are captured in the financials or not. Admin DD also gives a better picture of the kind of operational cost the buyer is likely to incur if they plan to pursue expansion of the target company.

2. Financial DD

One of the most important types of due diligence is the financial due diligence that seeks to check whether the financials showcased in the Confidentiality Information Memorandum (CIM) are accurate or not. Financial DD aims to provide a thorough understanding of all the company’s financials, including, but not restricted to, audited financial statements for the last three years, recent unaudited financial statements with comparable statements of the last year, the company’s projections and the basis of such projections, capital expenditure plan, schedule of inventory, debtors and creditors, etc.

The financial due diligence process also involves analysis of major customer accounts, fixed and variable cost analysis, analysis of profit margins, and examination of internal control procedures. Financial DD additionally examines the company’s order book and sales pipeline in order to create better (more accurate) projections. 

Many acquirers have a separate section of financial analysis focused on the target company’s debt situation, evaluating both short-term and long-term debt, applicable interest rates, the company’s ability to service its outstanding debt and to secure more financing if needed, along with an overall examination and evaluation of the company’s capital structure.

3. Asset DD

Another type of due diligence conducted is asset DD. Asset due diligence reports typically include a detailed schedule of fixed assets and their locations (if possible, physical verification should be done), all lease agreements for equipment, a schedule of sales and purchases of major capital equipment during the last three to five years, real estate deeds, mortgages, title policies, and use permits.

4. Human Resources DD

Human resources due diligence is extensive. It may include all of the following:

  1. Analysis of total employees, including current positions, vacancies, due for retirement, and serving notice period
  2. Analysis of current salaries, bonuses paid during the last three years, and years of service
  3. All employment contracts, with nondisclosure, non-solicitation, and non-competition agreements between the company and its employees. In case there are a few irregularities regarding the general contracts, any questions or issues need to be clarified.
  4. HR policies regarding annual leave, sick leave, and other forms of leave are reviewed.
  5. Analysis of employee problems, such as alleged wrongful termination, harassment, discrimination, and any legal cases pending with current or former employees
  6. Potential financial impact of any current labor disputes, requests for arbitration, or grievance procedures pending
  7. A list and description of all employee health benefits and welfare insurance policies or self-funded arrangements
  8. ESOPs and schedule of grants

5. Environmental DD

Due diligence related to environmental regulation is very important because if the company violates any major rule, local authorities can exercise their right to penalize the company, up to and including, shutting it down operationally. Hence, this makes environmental audits for each property owned or leased by the company one of the key types of due diligence. The following should be reviewed carefully:

  1. List of environmental permits and licenses and validation of the same
  2. Copies of all correspondence and notices from the EPA or state and local regulatory agencies
  3. Verify that the company’s disposal methods are in sync with current regulations and guidelines
  4. Check to see whether there are any contingent environmental liabilities or continuing indemnification obligations

6. Taxes DD

Due diligence in regard to tax liability includes a review of all taxes the company is required to pay and ensuring their proper calculation with no intention of under-reporting of taxes. Additionally, verify the status of any tax-related case pending with the tax authorities.

Documentation of tax compliance and potential issues typically includes verification and review of the following:

  1. Copies of all tax returns – including income tax, withholding, and sales tax – for the past three to five years
  2. Information relating to any past or pending tax audits of the company
  3. Documentation related to NOL (net operating loss) or any unused credit carryforwards of deductions or tax credits
  4. Any important, out-of-the-ordinary correspondence with tax agencies

7. Intellectual Property DD

Almost every company has intellectual property assets that they can use to monetize their business. These intangible assets are something that differentiates their products and services from their competitors. They may often comprise some of the company’s most valuable assets. A few of the items that need to be looked at in a due diligence review are:

  1. Schedule of patents and patent applications
  2. Schedule of copyrights, trademarks, and brand names
  3. Pending patents clearance documents
  4. Any pending claims case by or against the company in regard to violation of intellectual property

8. Legal DD

Legal due diligence is, of course, extremely important and typically includes examination and review of the following elements:

  1. Copy of Memorandum and Articles of Association
  2. Minutes of Board Meetings for the last three years
  3. Minutes of all meetings or actions of shareholders for the last three years
  4. Copy of share certificates issued to Key Management Personnel
  5. Copy of all guarantees to which the company is a party
  6. All material contracts, including any joint venture or partnership agreements; limited liability company or operating agreements
  7. Licensing or franchise agreements
  8. Copies of all loan agreements, bank financing agreements, and lines of credit to which company is a party

9. Customer DD

As customers or clients are the lifeblood of any business, the types of due diligence invariably include a close look at the target company’s customer base, with examination and analysis of the following:

  1. The company’s top customers: those who make the largest total purchases from the company and also the customers who are the “largest” in terms of their total assets – customers that are important regardless of their current level of spending with the company
  2. Service agreements and corresponding insurance coverage
  3. Current credit policies; run and review the days sales outstanding metric (DSO) to assess the efficiency of accounts receivable
  4. Customer Satisfaction Score and related reports for the past three years
  5. List, with explanations, of any major customers lost within the past three to five years

10. Strategic Fit

Acquirers are generally also very careful about exercising due diligence in regard to evaluating how well the target company fits in with the overall strategic business plan of the buyer. For example, a private equity firm considering a new acquisition will ask how well the proposed target will complement the firm’s existing portfolio of companies. A large corporation eyeing a possible M&A deal considers how easy (or how difficult) it is likely to be to successfully merge the target company into the buyer’s total corporate organization.

The following are some of the key strategic fit issues that acquirers look at and evaluate:

Does the target have important technology, products, or market access that the acquirer lacks and has need of or can make profitable use of?
Does the target have key personnel that represent a substantial gain in human resources?
Assess operational and financial synergies benefits that can be expected from the target’s integration with the acquirer
If the target company is to be merged with the acquirer or another firm the acquirer already owns, examine the plan for merging and project how long the merger process will take, and estimate the cost of implementing the actual process of merging the two firms
Determine the best personnel from both the acquirer and the target to manage the merger process

Other areas of due diligence research include IT networks, issues of stocks and/or bonds, research and development (R&D), and sales and marketing. Conducting thorough due diligence is critical to any successful acquisition. Without complete and intimate knowledge of the target company, it is impossible to make the best-informed decisions on mergers and acquisitions.

In a proposed merger or a situation where shares of stock in the acquiring company constitute a major part of the purchase transaction, the target company may look to perform its own due diligence on the acquirer.