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LEGAL DUE DILIGENCE

CERTIFICATE COURSE

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DEVELOPED BY

MODULE - 2

METHODS OF DUE DILIGENCE

There is no fixed procedure to conduct a due be clearly laid out. The areas to be covered and what
diligence. It varies according to the nature of the all aspects are to be covered under each area should
transaction, the type of business and scope of due be well defined. This should also include
diligence established by the client. For example, a due identification of specific areas that can involve a risk
diligence carried out for a joint venture will be less and procedures should be tailored to detect these
rigorous than the one conducted for a merger, risks. A proper time frame should be negotiated for
amalgamation or acquisition. However, there are completing the entire process, keeping in mind the
certain basic procedures that are followed in almost volume of information to be reviewed.
every due diligence exercise. This module highlights
these steps involved in a due diligence. A flowchart of the steps that should be followed in a
due diligence process is given below.
2.1 STEPS INVOLVED IN DUE DILIGENCE
The entire process can be divided into three stages:
Before investing time and resources into a lengthy
due diligence, it is advisable to undertake an initial (i) Preparation
assessment of the feasibility of the deal and get a (ii) Research/investigation
general idea about it. Once satisfied, the company can (iii) Analysis
start the process. It is important to keep in mind the
purpose of the proposed transaction, as the objective (i) Preparation: The first five steps in the flowchart-
of conducting a due diligence exercise is to provide from signing of the MoU and confidentiality
the proposer with all the necessary price and risk agreements to securing access to data- fall in the
information to make an informed choice. category of preparation. This is the stage before
the actual process of due diligence begins. It
In the initial stages, it is vital to prepare a clear road involves initial paperwork, such as signing the
map for the process. The steps to be followed should MoU and confidentiality agreements with the

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client. Confidentiality agreements form an liabilities, employee-related documents and
important part of the whole transaction since a lot various contractual rights and obligations. Apart
of the information that is provided to the firm (in from the documents, all the litigation associated
case a law firm is conducting due diligence) is with the company is also examined. An in-depth
sensitive information about the company. The check is done on all the statutory and regulatory
scope of the process depends upon the nature and compliances of the company to ascertain if the
context of the transaction. A questionnaire or company is in violation of any law or regulation.
checklist is prepared for the company undergoing
due diligence. The former includes questions (iii) Analysis: After the investigation phase, an
regarding the transaction and other business analysis is done of the findings and noted in a
activities of the company. The latter is a list of preliminary report. If required, clarifications are
documents and information that the company has sought from the company management. A final
to provide in the course of the diligence process. A report is then prepared that highlights all the
team is constituted to execute the entire process findings of the due diligence process. This report is
according to the terms of the MoU. Once access to then presented to the client who can then devise
data is secured, the review process can be an appropriate strategy based on the findings in
initiated. the report.

(ii) Research/Investigation: The next stage involves 2.2 METHODS OF CONDUCTING DUE DILIGENCE
investigation into the company’s data. The team
speaks to key personnel of the company and The core of a due diligence exercise is access to data
gathers information mentioned in the from the subject company. There are two ways in
questionnaire. A thorough research and review is which due diligence can be conducted:
conducted into the reports and documents of the
company to look for any risk or liability that may (i) By collecting fresh data from the company based
arise upon entering into a business relation with on a questionnaire: As stated above, a
the company. The documents reviewed generally questionnaire is prepared that includes the
include incorporation document, licenses and information that is to be asked of the company
permits, shareholder agreements, assets and undergoing due diligence. There is no one-size-
fits-all standard questionnaire. It depends on the

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kind of transaction and the scope of due diligence. diligence. They have to sign non-disclosure
One of the primary objectives of a questionnaire is agreements so that the data that is not in the
to identify hidden issues and address them public’s knowledge can be protected.
accordingly. Apart from questions, it also includes
requests for certain documents that may be Physical data rooms are usually located at the
required in the process. Since it forms an integral company that is being looked into. The due diligence
part of the entire exercise, it is vital to prepare a teams are taken there, where they conduct their
questionnaire that covers important areas review/research. Nowadays, virtual data rooms are
pertinent to the company and its industry. gaining popularity. It is an online version of the
physical data room. It allows the company to provide
(ii) By presenting pre-determined data: Under this information in a controlled manner and also
arrangement, an enormous amount of data is expedites the due diligence process. Since
presented to the party conducting due diligence in confidentiality is of paramount importance, access
a ‘data room.’ This room houses all the sensitive can be allowed to all documents or only a category of
and confidential data- the company’s legal documents to pre-approved individuals. The access is
documents, financial reports, regulatory secured with user identification and protected
compliance records and all other material password. Many providers of online data rooms allow
information about its business. The documents the company to track the movements in and out of a
that are brought to the data room are inspected data room.1 Some other advantages of a virtual data
there itself and returned once the process is room include saving costs, access to documents
complete. Access to this room is restricted to whenever required and easy addition/updating of
people involved in the due diligence process and a new documents.
few key people of the company undergoing

1Richard Harroch, ‘The Importance Of Online Data <https://www.forbes.com/sites/allbusiness/2016/08/15/th
e-importance-of-online-data-rooms-in-mergers-and-
Rooms In Mergers And Acquisitions’ Forbes (15 August, acquisitions/#5e6485335667>

2016), available at

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