Types of Due Diligence: A Practitioner's Note
CS RICHA KUMAR & ASSOCIATES
Types of Due Diligence: A Practitioner's Note
Legal, Financial, Bank, and specialised regulatory due diligence
What Due Diligence Actually Is
Due diligence is the careful, methodological investigation of a business — undertaken prior to an acquisition, restructuring, fund raise, or similar transaction — to verify facts, assess risk, and give the party proposing the transaction enough information to make an informed decision. It isn't limited to checking facts; it extends to evaluating, interpreting, and communicating them so a transaction can proceed (or be repriced, or be abandoned) on an informed basis.
Due diligence typically becomes necessary for: joint enterprise collaborations, partnerships, mergers and acquisitions, strategic alliances, outsourcing agreements, technology or product licensing, joint ventures, venture capital investment, and public issues.
⚠ A caution worth remembering: inadequate due diligence has real, well-documented consequences. Etisalat's $900 million acquisition of a 45% stake in Swan Telecom collapsed after the Supreme Court revoked the target's 2G licences — due diligence had failed to detect impropriety in how those licences were obtained. HP wrote off billions after spending only six hours on financial due diligence before acquiring Autonomy for £8 billion. These aren't edge cases — they're the reason due diligence exists as a discipline rather than a formality.
The Eight Recognised Types
Legal Due Diligence
Financial Due Diligence
Bank Due Diligence
Operational Due Diligence
Human Resource Due Diligence
Information Technology Due Diligence
Ethical Due Diligence
Strategic Due Diligence
The two most substantial for a CS practice — and the two covered in most depth below — are Legal Due Diligence and Financial Due Diligence, alongside the specialised regulatory diligence areas (FEMA, FCRA, Labour, Competition) that typically sit within a legal due diligence engagement.
1. Legal Due Diligence
Legal due diligence assesses all legal risks associated with a target company's organisational structure, assets, contracts, securities, and intellectual property — safeguarding the transaction by surfacing strengths and weaknesses before terms are finalised. It covers both intra-corporate and inter-corporate transactions.
Scope — assessing compliance under Company Law, Income Tax Law, Labour Law, RERA, SEBI regulations, the Insurance Act, RBI Act, FEMA, and Intellectual Property Law.
Documents typically verified:
Memorandum and Articles of Association
Minutes of Board and shareholder meetings (last three years)
Register of Members and charges
Share transfer deeds and share certificates issued to KMPs
Material contracts, loan agreements, and guarantees
Status of pending litigation, and orders/awards from regulators and courts
ROC filings, search/status reports
Details of branches and subsidiaries
Related party transactions and director-linked contracts/loans
Statutory registers and minute books
Transactions this typically covers: IPOs/FPOs/QIPs, mergers and acquisitions, private equity investment, corporate restructuring, leveraged buyouts, joint ventures, commercial agreements, and corporate governance matters.
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1a. FEMA Due Diligence
Covers all cross-border transactions — import, export, debt funding, equity capital infusion, and share transfers. Given the scale of inbound and outbound flows India now sees, and the penalty exposure for missteps, FEMA due diligence has become a distinct, high-stakes sub-practice in its own right. It covers:
Capital account and current account transactions
Currency transactions
RBI Master Directions, Regulations, and Circulars
FDI policy and approvals
Entry structure review — Liaison Office, Branch Office, Project Office, Wholly Owned Subsidiary, Joint Venture, FII/FVCI, NRI/PIO-linked matters
1b. FCRA Due Diligence
Relevant wherever an entity (typically an NGO — society, trust, or Section 8 company) receives foreign contributions. Under the FCRA, 2010, an organisation cannot receive foreign funding unless registered under the Act or specifically approved by government for a project. Post-registration, NGOs must file annual returns to the Ministry of Home Affairs within nine months of the financial year's close, alongside Income Tax filings.
1c. Labour Law Due Diligence
Particularly relevant in M&A, takeovers, IPOs, joint ventures, and winding-up scenarios. Reviews employment contracts, termination declarations, statutory records, and compliance under India's core labour statutes — Employees' Compensation Act, Payment of Wages Act, Minimum Wages Act, Factories Act, Maternity Benefits Act, Payment of Bonus Act, Payment of Gratuity Act, ESI Act, Industrial Disputes Act, Trade Unions Act, and the POSH Act, 2013. Its purpose is specifically to surface gaps before a regulatory audit does.
1d. Competition Law Due Diligence
Examines actual operating practice against the Competition Act — assessing exposure under three heads: existing and proposed agreements (supply/distribution arrangements, competitor agreements, non-compete covenants, technology transfer arrangements), abuse of dominance (market definition, existence of dominance, instances of abuse), and combinations (asset/turnover valuation, CCI notification status, post-merger dominance position). Findings here can materially affect deal value or trigger a withdrawal.
2. Financial Due Diligence
Verifies whether the financials represented in an Information Memorandum are actually accurate — going beyond the numbers to assess earnings quality, cash flow sustainability, asset condition, and hidden liabilities.
Covers: audited financials for the last three years, recent unaudited statements with prior-year comparables, accounting policy review, internal audit procedures, quality and sustainability of earnings and cash flow, asset condition and valuation, potential liabilities, tax implications of the deal structure, and reliability of the underlying information systems and internal controls.
Focus areas:
Quality of earnings, margins, and cash flow — seasonality, margin trends, GAAP application, revenue recognition practices, recurring vs. non-recurring items, capitalisation practices
Quality of assets / working capital — inventory turnover, current ratio, ageing debtors, WIP valuation, seasonal working-capital swings
Net debt — debt-like items (pension underfunding, severance obligations), loan agreements, debt restructuring compliance
Potential liabilities and commitments — contingent liabilities, off-balance-sheet items, pension obligations
Separation/structuring/integration issues — supply chain changes, MIS/accounting system compatibility, standalone cost impact, synergies
Related party transactions — arm's-length basis, cost-sharing arrangements, related-party financing
⚠ Illustrative example from practice: a transaction priced at 5x normalised EBIT (₹572 million, giving a ₹2,860 million purchase consideration) was renegotiated down by ₹380 million after due diligence revealed the reported EBIT included ₹84 million in one-off profit from a land sale — a clean illustration of why "normalised" earnings matter more than reported ones.
Financial due diligence extends naturally into tax due diligence — reviewing tax compliance, contingent tax positions, transfer pricing, identification of risk areas, and available tax planning opportunities.
3. Bank Due Diligence
Conducted by a bank whenever a company seeks to borrow. Its objectives: verifying director/promoter details, confirming statutory and procedural compliance, examining existing or prior charges and their satisfaction status, and checking directors' default history.
A Practising Company Secretary is specifically empowered to certify this under RBI Circular No. DBOD.No.BP.BC.46/08.12.001/2008-09 (19 September 2008) — issuing a Diligence Report in the format prescribed under Annexure III to that circular, on a half-yearly basis.
To issue this report, the PCS must have access to the company's books, minute books, statutory forms and returns, and records — wherever held — and may seek a letter of representation from the company for matters not independently verifiable (e.g., show-cause notices received, related-party disclosures).
Where the PCS cannot form an opinion on a matter, or where scope is restricted by the company or by circumstances (e.g., documents held by a third party or government authority), the report must state this limitation explicitly — including, where material enough, a statement that the PCS is unable to report compliance in the absence of necessary information.
⚠ Professional responsibility is real here. A false or negligent Diligence Report exposes the PCS to disciplinary action under the Company Secretaries Act, 1980, and potential liability for injury caused by that negligence.
Disqualification from issuing a bank Diligence Report applies to a PCS who is: a body corporate; an officer or employee of the company; a partner or employee of such an officer; indebted to the company beyond ₹1,000, or a guarantor for such indebtedness; or a holder of the company's voting securities. These disqualifications extend to the company's holding and subsidiary entities as well.
The Three-Stage Process, Regardless of Type
Pre-Diligence — Letter of Intent/term sheet, execution of the Non-Disclosure Agreement, data collation, and initial issue identification.
Diligence — data room inspection, document analysis, risk-and-return evaluation, and submission of the Due Diligence Report (summarised or detailed, as scoped).
Post-Diligence — rectifying identified non-compliances, negotiating the Shareholders' Agreement, and, where required, filing applications or petitions relating to identified offences.
A due diligence report typically structures into three parts: an Executive Summary (leading with the most critical findings or deal-breakers), the Main Body (following the checklist/terms of reference), and Appendices (supporting data sheets and documentation). Findings generally fall into one of four categories: deal breakers, deal diluters (quantifiable penalty exposure that reduces value), deal cautioners, and deal makers.
CS Richa Kumar & Associates
www.csrichakumar.com · richakumar86@gmail.com ·
This post is for general informational purposes and does not constitute legal advice. For guidance specific to your situation, consult a qualified professional.
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