Due Diligence Review

A term sheet is only an offer. Before real money moves, the AIF has to check that what the company said about itself is actually true.

That check is the Due Diligence Review, or DDR. It does not start until both parties have signed the term sheet. The investee company then opens up its records, and the AIF's team goes through them in detail.

The workbook splits DDR into three parts. Business, commercial and technical DDR looks at the company's operations, usually done by the AIF's own investment team. Financial DDR checks the books and taxes, usually done by an outside accounting firm or investment bank. Legal DDR checks contracts, IP and litigation, usually done by a law firm.

Timing. The due diligence process 'does not commence unless the term sheet is executed by both parties.' Once it starts, the investee company provides detailed confidential records in a virtual data room.

The three components:

1. Business, commercial and technical DDR — normally run by the AIF's own investment team, using its in-house expertise and industry network; technical experts may be engaged for specialised technology.
2. Financial DDR — verification of books, financial statements and business transactions, usually covering at least the past three financial years, plus direct and indirect tax matters; usually carried out by an accounting firm or investment bank engaged on the manager's behalf.
3. Legal DDR — the company's legal aspects, IP protection, material contracts, outstanding litigation and statutory compliance; normally run by a law firm practising corporate and transaction law. Compliance aspects are sometimes folded into financial DDR, or handled by a practising company secretary.

Output. DDR results in a confidential report to the investment manager. A copy is generally not shared with the company, though an extract may be sent for clarification. Findings feed a more detailed, realistic financial model, which can trigger renegotiation and a revised, final term sheet — the one that becomes the basis for the definitive agreements.

A naming trap the workbook itself creates. It states DDR 'is sometimes known as investor due diligence or IDD' — but elsewhere on this platform, 'investor due diligence' and the abbreviation 'DDR' describe the opposite direction: an investor's own check on a fund and its manager before committing capital. In this chapter, DDR runs the other way — the AIF's manager checking an investee company. Read the direction from context, not from the abbreviation alone.

Vindhya Capital, managing a Category II AIF, executes a term sheet to invest Rs 60 crore in a logistics company. DDR begins the same week.

The investment team itself handles business and technical DDR, visiting warehouses and checking fleet utilisation data. Vindhya engages an accounting firm for financial DDR, which covers the company's last three financial years and flags a potential Rs 2 crore service-tax exposure. A law firm runs legal DDR and finds an unresolved trademark dispute with a competitor.

None of the three reports goes to the company directly. Based on them, Vindhya's team rebuilds its financial model with more conservative margin assumptions, and renegotiates the valuation down before signing the final term sheet — the trigger for the Share Subscription Agreement that follows.

Chapter 7 (Investment Process and Governance of Funds), section 7.2 (Due Diligence Review), sets out the three-way split and the sequencing — after the term sheet, before the definitive agreements. Expect a question on what triggers DDR to start, on which of the three components is normally run by an outside accounting firm, or on whether the DDR report is shared with the company (generally, it is not).

• DDR does not start until the term sheet is executed by both parties — not at the teaser stage, and not at the management presentation.
• 'Investor due diligence' and 'IDD' mean two different things depending on direction. In this chapter they describe the AIF checking the company; elsewhere on this platform the same words describe an investor checking the fund. Do not assume the abbreviation alone tells you which way the check runs.
• Financial DDR is usually outsourced; business DDR usually is not. The investment team's own expertise covers the business and technical side; an accounting firm or investment bank is normally engaged for the financial side.
• The DDR report is generally confidential to the manager. An extract may go to the company for clarification, but the full report normally does not.