What You Need to Know About Conducting Due Diligence in India: Q&A
Foreign companies looking to do business in India should perform a due diligence check to identify or prepare against any possible risk exposure. Due diligence is usually conducted in cases of mergers and acquisitions, partnerships, joint ventures, and IPO.
It should also be noted that companies in India have to comply with different legal and regulatory compliance requirements, and the tax regime can be difficult to navigate. Therefore, due diligence is required to ensure that the local company is in compliance with all the necessary laws and rules, and has been providing accurate information to the foreign company inquiring about its business.
India Briefing spoke with Sunny Makhija who looks at international business advisory at Dezan Shira & Associates’ India Offices on the important considerations for foreign companies conducting a due diligence check before making their foray into the Indian market.
When should a foreign company conduct due diligence?
Sunny Makhija: There are a couple of cases where a foreign company should conduct due diligence. If it is entering into a merger and acquisition (M&A), then due diligence should be conducted from the perspective of the buyer as well as the seller. It should also be conducted in case of a strategic alliance, business partnership, joint venture, or an IPO.
Due diligence is also conducted if the foreign company is interested in conducting background check of a personnel like a partner, supplier, or a country head.
Why should a foreign company conduct due diligence before entering into a business deal in India?
Sunny Makhija: It is important to conduct due diligence to a avoid bad transaction, identify issues within the company, and verify that the business is what it appears to be. Further, through this process, information about the company’s value and assets is also revealed. It further helps in assessing the reputation and corporate governance of the company.
What are the types of due diligence that foreign companies should consider while investing in India?
Sunny Makhija: Major types of due diligence in India are legal, financial, HR, and commercial. Legal due diligence focuses on examining the legal basis of the transaction. It requires
a thorough analysis of the documents, company’s existing contracts, agreements, ongoing and pending litigation, etc.
During the time of investment, it is important to understand the past financial statements, book of accounts, and compliance adherence. This helps to provide a thorough understanding of
company’s financial health including any hidden liabilities and their future impact on business.
Typically considered a ‘soft’ concern, HR due diligence has an expanded scope in India. It constitutes understanding the country’s system of employment contracts, labor laws, labor relations, regulatory policies, work culture, and industry standards. Identity markers such as class, caste, gender, ideology, religion, and tribe, among others, greatly influence labor relations in any of India’s distinct regions and must be fully understood prior to market entry.
Commercial due diligence assists in understanding the market of the target company. It provides a full overview of the target’s internal and external environmental factors. It highlights the position of the target company in the market and its ability to reach the forecast goals and objectives.
Other types of due diligence assist in understanding the areas such as operations, information technology, intellectual property, and vendor relationships, among others.
How important is it for firms to conduct pre-investment due diligence?
Sunny Makhija: Pre-investment due diligence is a process to mitigate risks and to aid sound decision making. It helps in minimizing the extent of unknown risks or liabilities about a business. It helps in raising the red flags before a deal goes through and consequently adjust the price and other important terms and conditions of a deal. It also assists in gaining a complete picture of the business and checking the synergy with existing business. Thus, giving practical insights on doing business in India.
Based on the result of due diligence process, parties can either go ahead with the deal, negotiate further, or walk away.
Should due diligence be limited to certain types of business dealings?
Sunny Makhija: While due diligence is advisable in several cases, it is an important part of the joint venture process. As no two companies are same, it is important to obtain and unveil any information that can have an impact on the sale and purchase of a company or its assets.
However, the necessity to carry out a due diligence can at times be dependent on the structure of a joint venture. If two companies are merging to form a new third company for carrying out a new business activity, then due diligence may or may not be required.
On the other hand, if the joint venture results in acquisition of an existing company then a due diligence is always recommended.
What areas of tax and regulatory compliance come under a due diligence check? What should foreign companies prioritize in India?
Sunny Makhija: Conducting tax due diligence during an M&A deal is important as it helps in uncovering tax issues and leakages. At times, tax due diligence may also help in unveiling potential tax benefits which the target company is not availing.
Understanding the tax nuances also helps in structuring the M&A deal in an overall tax efficient manner.
Balance sheet, related schedules, and profit and loss statements assist in capturing the relevant tax information of the target company.
Such documents reveal aggregate taxes paid, current tax charge, and deferred tax charge for the relevant year. Financial statements also disclose tax disputes, demands against the company, contingent liabilities, among other important details.
It is also advisable to conduct analysis of effective tax rate, deferred tax rate, and review of MAT status. Master data from the corporate affairs ministry is analyzed to review details of the target company established under the Companies Act, 2013. Information contained in certificate of incorporation, articles of association, memorandum of association, authorized capital, paid-up capital, quantum of secured loans can give a good overview of the status of the company during the due diligence process.
During the M&A, it is important to make sure that the target company is in compliance with the FDI policy of India. Investment in certain sectors and activities is prohibited or limited by the FDI policy. Compliance with Foreign Exchange Management Act (FEMA) is also mandatory. Compliance with annual return on foreign liabilities and assets (FLA Return), annual performance report helps in shedding light on assets and liabilities of the company and if any overseas direct investment has been made.
Why is it important for foreign companies to conduct HR due diligence in India?
Sunny Makhija: It is important to conduct HR due diligence to correctly evaluate the overall HR procedures, processes, and human capital in a company. Such type of due diligence helps
- HR policies, governance, and code of conduct guidelines;
- Any cultural differences between organizations which may result in a conflict in future;
- Payroll contractual obligations of the target company with its resources. Analyzing salary structures, cost to company details, lock in periods, no compete contracts, and severance package;
- Potential frauds in background details of employees;
- Labor issues, social security obligations and labor compliance status;
- Relationship with trade unions and bonding among the workmen; and
- Pending litigation against employees or company.
Why is it advisable to employ a local professional services firm for conducting due diligence?
Sunny Makhija: If you are planning to invest in a business in India, then it is advisable to conduct a thorough due diligence of the target company to identify potential risks and opportunities well in advance. A seasoned due diligence team assists in making the right decision and ensures no checkbox is left unticked. Dezan Shira & Associates is well equipped to assist in your due diligence requirements.
Our team of experts and associates have deep understanding of India’s unique challenges and can provide comprehensive support in undertaking financial, legal, tax, vendor, HR, commercial, and any other type of due diligence undertaking required.
For advice on doing business in India and exploring your investment options in this market, please feel free to email us at firstname.lastname@example.org.