Chapter 5 - Due Diligence

Question 1

Definition of Due Diligence

Answer 1

It’s a detailed examination. Detailed and thorough examination and analysis conducted by an organization prior to making a business decision and commonly applies to voluntary investigations.

Question 2

Purpose of Due Diligence

Answer 2

To bring together legal and other professionals with specialized expertise whose collective responsibility is to: a. Perform an investigation of a business, situation, activity or person to assist with effective decision-making. b. Assess the health and viability of a business or entity. (Look before you leap).

Question 3

When to Use Due Diligence

Answer 3

1. Merger and/or acquisition
2. Purchase of new assets, particularly real property
3. Development or modification of a product, service or process.
4. Undertaking of a joint venture or contract.
5. Establishing or altering relationships, ex. hiring and firing personnel, choosing a new supplier or service provider.

Question 4

SWOT Defined

Answer 4

Common method of analyzing where the organization has its strengths and weaknesses as well as analyzing what threats and opportunities exist to determine internal and external opportunities available to an organization.

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Question 5

What types of buy-sell agreements might be considered?

Answer 5

Merger, Acquisition, Divestiture

Question 6

What is a merger

Answer 6

Two or more organizations agree to move forward as one new entity and issue the appropriate ownership interests (common stock, memberships, partnerships, etc) Come together.

Question 7

What is an acquisition

Answer 7

One organization takes over all or part of another organization and is established as the new owner with ownership interests continuing unchanged (entity or assets).

Question 8

What is a divestiture

Answer 8

When an organization decides to sell off investments or business interests in a subsidiary (don’t want to have a certain product line).

Question 9

Types of Mergers and Acquisitions

Answer 9

Horizontal, Vertical, Conglomerate

Question 10

Horizontal Merger

Answer 10

Combines firms in the same industry (Coke and Pepsi). Increase size, increase market power and gain efficiency.

Question 11

Vertical Merger

Answer 11

Combine firms in the same industry. Provide tighter integration and increase control. (example, Amazon buys UPS).

Question 12

Conglomerate

Answer 12

Combination of unrelated companies. Increase company’s diversity. (example is Disney & ABC).

Question 13

What are the 4 steps of the Due Diligence Process?

Answer 13

Step 1: Strategy & Expectations
Step 2: Identification & Analysis
Step 3: Decision-Making with the Team
Step 4: Post-Transaction

Question 14

Explain Step 1 in Due Diligence Process. (Strategy & Expectations).

Answer 14

1. What are your needs and how do you plan to address them?
2. What is the task or target? What are we changing?
3. Requirements: What is the desired result? Is there a hurdle rate? Are there make or break scenarios?
4. Set a Timeline
5. Define roles and responsibilities to avoid overlap or duplication of efforts and eliminate power struggles.
   When Forming a due Diligence Team, members need to be selected strategically to ensure that the team:
   - Represents each functional business area of the organization
   - Has knowledge of cross-departmental risks and understands how changing one variable can affect another.
   - Has a vested interest in and knowledge of the organization as a whole.
   The Team will include:
   - The Risk Manager
   - Senior Leaders or Reps from each key functional business area
   - Legal Representation
   Key Responsibilities
   - Explain the purpose, nature and structure of the deal.
   - Explain expected scope of the due diligence team’s efforts.
   - Explain any issues related to the process.

Question 15

Explain Step 2 in Due Diligence Process (Identification & Analysis)

Answer 15

Ensure all info is complete and accurate:
- Background info - conduct interviews, check references
- Company info - discontinued products, services or operations; successor liabilities from previous acquisition or consolidations
- Financial Information - review financial documents, cash flow funding mechanisms
- Key exposure areas (depending on the type of business) ex. products/general liability; environmental; workers comp, contractual and professional liability, business interruption and extra expense; regulatory agency citations; fines; and improvements required by OSHA, EPA, EEOC, ADA etc.
- Risk Management Program:
Program activities and functions
Risk financing arrangements
Loss history and insurance info including policies, claims-made policies, tail coverage, premiums, claims records, workers comp experience mod and litigation records.

Question 16

Explain Step 3 in Due Diligence Process (Decision-Making with the Team)

Answer 16

1. Report back findings from Step 2 - summary of exposures uncovered, appraisals and estimates, expert and professional reports.
2. Perceived value from the transaction
3. Liability that will be assumed through the transaction
4. Identify any critical transition issues
5. Integration issues, facility closures, new construction, retrofitting, etc.
6. Determine impact on other functions within the organization.
7. Identify the worst-case scenario in any given situation with an estimate of what is most likely to happen.
8. Review key assumptions and make recommendations to management.
9. Tax implications and structure of the sale (entity, asset, liability).

Question 17

Explain Step 4 in Due Diligence Process (Post-Transaction)

Answer 17

1. Identify and address new exposures.
2. On-site inspection of locations, particularly if subject to closing
3. Organizational structure, culture, leadership, policies and procedures.
4. Consolidate or separate programs a. Human Resources b. Risk Management Departments c. Safety d. Other departments e. Insurance f. Claims Management.