DD for IPO

A.S. Yermolenko Head of FBK-Law corporate practice, Ph.D. in law
The first of the abbreviations used in this headline was established in business vocabulary long ago. The procedure it denotes is popular in economic practice. The very phrase "due diligence" -- literally, "due care" or "due attention" -- is used to denote the overall audit of company activity, as well as separate audits of other components of business: legal, tax, financial, construction or corporate due diligence. In most cases, such an audit is conducted by the investor at the purchase of someone's business or when making a decision regarding participation in someone's business.

However, due diligence is a rather universal tool, allowing the obtainment of a general picture -- that is, a description of all material aspects of a company's activity. That is why it can be used (and is used) not only by an external investor, but also by the company owner himself and by company management in some cases.

Depending on the purposes that the client ordering audit sets, while at the same time retaining general and principal approaches, a due diligence procedure has its own peculiarities. When revealing problems, experts use various visual angles. For instance, a large-scale transaction executed in the wrong way may have serious consequences for an external investor and is an argument for decreasing the price when purchasing a business or block of shares. At the same time, this is of no importance should we be talking of the examination of a group of companies before restructuring.

When conducting an IPO, due diligence has its own specific purpose, considering the fact that the company is aimed at engaging investments not due to a one-time transaction but for a long-term period: to reveal the principal drawbacks of a business organization influences its appeal to a wide range of potential buyers of a company's securities. To reach this very result, an audit is usually conducted in three main directions.

First and foremost is an organizational analysis; you shall analyze the structure of a group of companies, its transparency and controllability; affiliation, unjustified crossholding or other structural drawbacks that may cause anxiety and decrease the business's appeal are revealed and eliminated.

The second group of issues subject to analysis is legal issues arising during company activity. When conducting an analysis in this direction, adherence to legislative requirements at the formation of capital stock, equity issuance, detection of risks related to their encumbrance, observation of shareholders' rights including those related to profit distribution, company rights to material tangible and intangible objects, including land sites necessary for development of a company's realty objects are subject to audit. Besides, one shall detect basic encumbrances of significant property. The system of basic contractual and economic relations, as well as licenses and permits providing for the functioning of a business, is subject to consideration during legal due diligence.

The third aspect subject to investigation and reflection in the report drawn by the results of due diligence is finances and taxes. One shall reveal the main issues related to financial flows, volumes of accounts receivable and payable, define cost and profit centers inside the group of companies, as well as the correct payment of taxes and risks related to possible claims on the part of controlling bodies.

The preliminary audit in preparation for an IPO can be conducted both by company employees and engaged consultants. Final confirmation of the results related to the elimination of risks and adjustment of a company, as well as fixing a company's appeal for investors requires confirmation by the leading independent consulting and law companies.