Due Diligence

×

Financial Due Diligence , along with Legal and Tax Due Diligence, are considered classic types of Due Diligence.

The purpose of financial due diligence is to study the financial condition of the object, as its name implies. When conducting financial due diligence, the financial accounts of the target facility will be examined. The data is usually processed for the last three years. However, in order to see the long-term functioning of the target object, the annual reports of the nearest 10 years may be studied, thereby creating an overall picture of the profitability of the enterprise, taking into account its strengths and weaknesses. In addition, the production of the accounting book, balancing, in order to analyze the risks of the financial account, the existing projects, credit history, obligations, transactions, etc. are checked from the financial point of view. Past activities are studied.

By carrying out financial due diligence, it is possible to assess the financial risks of the enterprise. However, checking the annual accounts is a thing of the past, and in order to assess the sustainable development prospects of the enterprise, it should be "cleaned" of all non-operating items and non-recurring items.

In "clearing" the results of the enterprise, it is also important to take into account the nature of the enterprise participating in the concern, i.e. the figures and data presented in the report, to the extent that the information obtained excluding these factors should be analyzed with great accuracy, because naturally the seller will try to present the target object more attractively. Financial Due Diligence is not the same as enterprise valuation, however, any enterprise valuation document should include financial due diligence, as the results of the valuation, which relate to future liabilities, cash flow, must be taken into account when valuing the enterprise.

The results of financial due diligence contain important information for the evaluation of the enterprise and its development in various scenarios, however, it does not investigate the value of the enterprise.

×

Commercial Due Diligence It is mainly aimed at studying the object's efficiency in economic relations. In order to achieve this goal, the market situation of the target object at that time, products and its key ways, as well as the activities of other entrepreneurs operating in the same market, should be investigated. Accordingly, the competitiveness of the target object in the market. It is necessary to analyze the market structure and its players in order to properly plan future changes if necessary.

×

Tax Due Diligence In practice, tax due diligence is often a supplement to legal due diligence and is performed together. The purpose of tax due diligence is to identify the tax risks of the target object. For example, is there an undervaluation of assets and vice versa, revaluation of liabilities, the issue of hidden income, does the company benefit from any special tax or customs benefits or vice versa, is there a threat of an increase in output in this regard, etc. Tax inspection can be divided into two directions. In the case of the first one, existing tax or future obligations, which may arise in the company's usual mode of operation, should be studied. The second area of ​​interest includes the study of how the acquisition/merger transaction should be carried out in the most tax-friendly manner for both the buyer and the seller. Practice shows that tax due diligence is carried out in close contact with persons performing financial due diligence, as well as with the involvement of lawyers who work directly on the formation of the agreement and are involved in the implementation of legal due diligence. Not so rarely, the period of validity of guarantees agreed in the direction of tax obligations is much longer than that of other contractual obligations and is equal to the limitation period established by the law of a specific tax. The role and importance of Tax Due Diligence seems to be somewhat diminished compared to other types of Due Diligence, however, precisely a number of latent tax liabilities can completely disrupt or change the course of a transaction. During the asset deal of the enterprise, the object bearing tax liabilities is not transferred and the liabilities remain with the alienating society, therefore tax inspection is important during the share deal of the enterprise. In practice, acquisition/merger transactions are more often carried out in the form of equity acquisitions. In order to detect latent tax risks, it is necessary to identify the tax obligations that are not due at that time, the detection of these risks is necessary for the interested party, since, in addition to the fact that each country has a unique tax system, the tax burden as a result of the transaction is also different. When characterizing the types of transactions, it was noted that both property and share purchase, in addition to cash settlement, may be carried out through shares. The mentioned method is usually the most economical from the tax point of view, if naturally it does not hinder the parties in any other way. It is desirable to compare the obtained data with the results obtained at the stage of financial due diligence, in particular, the amount of tax obligations the company has to fulfill as a result of the annual report. In terms of tax obligations, value added tax is noteworthy. Today, it is important to identify two potential risks, the first is hidden service tax, which occurs when shareholders or other persons close to the public provide certain services to the public at a much lower or higher price than the real value (arms length principle), the second - hidden reserves. From a tax point of view, the existence of none of them is good for the company, because eventually if they are found, it is necessary to tax them, that is, an additional cost will arise. Also, the nature of the purchase depends on whether the buyer or the seller will be taxed. Taxation rules are naturally different in the legislation of each country. It is important to note whether the purchase is made through foreign investment, because in this regard, different taxation rules may be provided in accordance with the bilateral agreements of specific countries.

×

Environmental Due Diligence - Due to the increased damage caused to the environment, environmental due diligence is no less important than legal, financial, commercial or tax due diligence. Within the framework of the mentioned research, ways to avoid industrial waste decontamination, water pollution and other possible risks or damages should be identified, which in many cases is associated with quite large costs and not infrequently increases the transaction cost. In carrying out environmental due diligence, as in other types of inspections, the starting point is the identification of risks that will harm the environment at a given moment and in the future. This type of inspection is becoming more relevant every year due to the strengthening of environmental protection legislation and the high cost of environmentally friendly installations. The law of a number of developed countries actually obliges the potential owner to know in advance all the issues related to the enterprise's relationship with the environment. During the implementation of environmental due diligence, the legislation related to environmental protection, requirements, soil, water, the impact of production on natural resources, etc. should also be studied. In addition to the above, a number of product manufacturing and production process safety issues are noteworthy, which are also closely related to the implementation of environmental due diligence. This type of inspection is important for such enterprises that operate in the direction of production and their production affects the environment, has emissions, requires waste processing, etc.
Naturally, environmental due diligence is not carried out at the same level in all types of transactions, its scope and importance depends on what kind of enterprise it is and how much its current or future activities are related to the implementation of any impact on the environment. If environmental due diligence is critical to the transaction, such due diligence is usually divided into two phases. First of all, the documentation is studied in specific directions, to what extent the enterprise complies with legal norms, whether their production standards comply with mandatory requirements, how waste is disposed of, how the land is cultivated, etc. In order to better study the problematic issues discovered as a result of overcoming the first stage, an on-site inspection and study is conducted, after which a plan is made whether the enterprise needs to be retooled, what specific steps will be taken to meet the standards, what costs will all this be related to, etc. Naturally, environmental due diligence should be carried out through specialists in the relevant field and lawyers specialized in the field of environmental protection law.

×

Personnel Management Due Diligence Personnel management due diligence is specific to the extent that the object of its study is a person and the economic profit of a person for a specific enterprise. Undoubtedly, to a large extent, the success of the company depends on the human factor, it is the person who is the main creator of economic wealth. Therefore, waiting for the effect of synergy, setting commercial, strategic, financial or other types of plans may be in vain if there are no people in the company who will implement the set goals. However, despite its importance, Due Diligence of personnel management is considered a kind of "soft power" and its direct reflection in numbers is rare. That is why its results are less known to the general public. The majority of Western countries protect the rights of employees quite thoroughly, and even unfavorable results obtained within the framework of Due Diligence cannot be grounds for mass dismissal. Due to these and many other factors, despite the importance, often personnel management Due Diligence is limited to the study of employee contracts, their compensation, which is largely reflected in legal or financial Due Diligence. In this direction, the issue of personal data is also noteworthy. They should not be disclosed and the authorized persons of the target facility should be careful about what kind of information they give out as part of the due diligence. The protection of personal data does not depend on the good will of the employer, but is protected by law. In particular, the transfer of personal data of employees (name, surname, marital status, religious affiliation, education, performance, photo, health status) within the framework of Due Diligence is not allowed by the Personal Data Protection Law of Georgia. On the basis of the same law, the release of personal information is allowed only if the consent of the employees themselves has been obtained in connection with the release of information. However, such information is usually provided at the final stage of due diligence, when other components are satisfactory to the interested party and there is little time left before the conclusion of the contract. Article 50 of the Labor Code of Georgia, which regulates the issue of labor contracts when transferring an enterprise, is undoubtedly noteworthy. The mentioned article was included in the Labor Code of Georgia with the amendment of September 29, 2020. For the purposes of Article 50 of the Labor Code of Georgia, the transfer of an enterprise means the transfer of an enterprise or business or a part of an enterprise or business to another employer on the basis of a transaction or law, which includes, among other things, the transfer of economic activity, during which its identity and/or essential similarity is preserved and which refers to the organized grouping of resources for the implementation of basic and auxiliary economic activities. It is not allowed to terminate the employment contract by the transferor of the enterprise or the receiver of the enterprise on the basis of the transfer of the enterprise. Other grounds for terminating the contract naturally remain valid and the employer has the right to use them as needed. The mentioned article is really a big step forward in terms of protecting the rights of employees during the transfer of the enterprise or its part. It is worth noting the regulations established by the Law of Georgia on "Personal Data Protection", which contain special norms of information processing and in general, restrict the right of the employer to dispose of the personal data of the employees only at his own discretion, without the consent of the person.

×

Cultural Due DiligenceImplementation largely serves to successfully implement future transactions. Although the number of acquisition/merger transactions worldwide is increasing, the percentage of their failure is quite high. 70-90% of mergers in the international market are unsuccessful. The reason for failure is often the cultural difference of the companies, when the acquiring and target companies operate in different cultural contexts, even if it is a transaction between two companies of similar strength. However, cultural due diligence is highly intuitive and rarely has a rigidly structured character. Cultural Due Diligence is mainly used during international transactions, when radically different cultures, both at the company and country level, are combined, because culture, as a system of values, norms, and views uniformly shared by a group of people, has a great influence on the company's management and on success. Cultural Due Diligence may overlap with Human Resources Due Diligence, if within the scope of the latter, targeted interviews with employees were conducted and specific cultural features of work management and enterprise management were identified. Cultural Due Diligence may be performed as a pre-merger. Conducting cultural due diligence and performing a specific analysis after it is performed is not a simple process, but it can have a large potential impact on the future fate of the transaction.

×

Information Technology Due Diligence Having a proper information technology system is essential for the functioning of a modern enterprise. Although the role and importance of information technology in the execution of a transaction is increasing, information technology due diligence is rarely conducted in isolation. It is important to find out whether all the existing programs are licensed, whether personal data is properly stored and protected, how protected the internal systems are from the penetration of outsiders, also, many devices are managed by computer, therefore, their protection systems must function properly, etc. Sh. In addition, the majority of employees in the enterprise own a personal computer, which is connected both to the internal network and to the global Internet, which is a source of additional danger, because it is possible to download various programs from the Internet to the work computer, which can potentially endanger the protected, work-important information on the computer. . The use of personal smart phones and other electronic devices by employees for official purposes further increases the threat. In addition to information technology (IT), it is important to consider the so-called Production technology (PT), which is a combination of process, equipment and know-how used to create a product or service. Due to the fact that today almost all information related to the enterprise, including financial reports, future plans, know-how information or other confidential information is stored in computers, not to mention the computerized management of production facilities, it is important to protect them from cyber attacks and other information leaks, accordingly , it's no wonder that with the advancement of technology, IT Due Diligence has become a pressing issue.

×

Due Diligence Compliance - Violations, which are individual for each enterprise, can lead to both civil and criminal liability. Due to its importance, many large companies have even created special Compliance departments. Due to the fact that compliance with relevant norms is not always documented. Similar type of Due Diligence (if needed) is not conducted in parallel with Legal, Financial or Tax Due Diligences. Risks related to Compliance are divided into two parts, in the first one there are violations that have already been carried out, which have not yet been discovered, therefore, its consequences are not permanent. Due Diligence at this time focuses on assessing possible outcomes and their implications. In the second part, there are such types of violations that refer to possible future violations that test the effectiveness and actual functioning of the existing system for detecting and evaluating existing risks. In terms of Compliance Due Diligence, the transaction process itself may pose a potential threat, especially the opportunities and threats of disclosure of information provided during the Due Diligence process. Violation of Compliance, in addition to real responsibility, also causes great reputational damage. In this regard, issues related to cartel agreements and abuse of dominant position may be particularly important, the consequences of which can damage the company both financially and reputationally. In terms of compliance, issues related to possible corrupt transactions are also a significant risk.

Compliance Due Diligence is also often the subject of data protection issues, both personal and other types of data, the disclosure of which could harm the company. The discovery of compliance violations in the process of transaction planning and enterprise evaluation and study for two-thirds of the enterprises that conduct similar type of due diligence has become the basis for the failure of the transaction. The data is quite impressive, therefore, the detection of risks related to Compliance is important and often even essential in the preparatory stage before the implementation of the transaction.

×

Strategical Due Diligence The subject of the study is the mutual agreement between the goals of the investor and the development perspective of the target company, imbued with specific industrial, financial or speculative goals.

×

Legal Due Diligence The purpose of legal due diligence is to perceive and assess the legal relations of the object under study with maximum accuracy. Accordingly, we present as the subject of study and assessment: the company's founding agreement, statutes, agreements between the company and directors, rental, lease and leasing agreements, documentation regulating relations between clients and suppliers, labor-legal relations, existing or future potential disputes, licenses and/or permits. , obligations related to environmental protection, belonging to Real estate and related relations, debt obligations, etc. If the enterprise has subsidiary enterprises, it is also necessary to study the documentation related to them. In many cases, it becomes necessary to study and analyze the relationships related to anti-competitive agreements. Also, it is important for a foreign investor to analyze the purchase agreement, study its structure, what elements it consists of, what are the minimum guarantees offered by the legislation, etc.

The subject of the study is also the governing bodies of the society, the board (directorate), the supervisory board (if any) and the general assembly. It is important for the interested party to know what leverages he has in relation to the current management of the enterprise, whether he can release them, what procedures need to be followed, what kind of agreements are concluded with them, etc. In terms of property relations, the function of legal due diligence is expressed in analyzing the correctness of accounting of assets and liabilities of the enterprise.

Also, in the enterprise, there may be certain bodies (e.g. councils) that cannot influence decision-making, although it may be interesting for interested parties to study their rights and duties, even from an information point of view.
From a legal point of view, if it is a merger transaction, it is also important to find out whether the particular merger is subject to notification. The Law of Georgia "On Competition" establishes merger control under Articles 11 and 111, the same will be established with respect to the legislation of other countries, so as not to disrupt the transaction due to failure to notify the relevant authority of the merger. Legal Due Diligence creates a very important information platform for all players and facilitates decision-making. During its implementation, in general, the legal framework surrounding the enterprise is defined and all aspects necessary for the perfect implementation of the transaction from a legal point of view are studied. A potential buyer is interested in discovering the legal relationships and risks surrounding the target facility. It is not in the buyer's interest to blindly trust the seller and receive a defective item. Just not having a legal flaw does not in itself mean a high value of the enterprise, proper contracts and other legal nuances are valuable when accompanied by economic soundness.

×

Intellectual Property Due Diligence At the same time that issues related to intellectual property are gradually becoming the object of more interest in the world, the role of intellectual property due diligence has significantly increased. This was largely due to Facebook's purchase of Instagram for one billion dollars in 2012. This was surprising and incomprehensible to many, because at that time Instagram did not make any profit, the price was determined by the number of users of the platform, related technologies and know-how attached to employees. Today, the size of Instagram, both financially and in terms of users and valuable employees, is much increased, and it is believed that Facebook's decision was one of the most justified acquisition transactions. Intellectual Property Due Diligence focuses on in-depth research of all types of rights, patents, trademarks and other intangible assets. All this may be the subject of research during legal due diligence, although in the case of the latter, the examination is carried out from a purely legal point of view, and the economic or monetary value of intangible assets is not counted. Therefore, if the target object is a company that owns an intangible asset that is important from an economic point of view not only at the given moment, but also in the long term, the implementation of intellectual property due diligence is not only desirable, but even necessary.

×

Real Estate, Strategic and Relevant Market Research Due Diligence In addition to the types mentioned above, depending on the specifics of the enterprise and interest of the interested party, real estate research, strategic or relevant market research Due Diligence may be conducted. Each of them naturally has its own function. Real estate is the main part of the assets of many companies, so it is not surprising that such properties become the subject of special study. Specialists in the relevant field evaluate the value of the property, the possibilities of increasing or decreasing the value of the property in the wake of the development of the economy of a specific country in the short or long term, the actual condition of the real estate, the loan or other obligations related to them, etc.