Introduction
Illegal acts by the board of directors or managers to the detriment of the company or owners can lead to significant financial damage, reputational damage and lengthy litigation. The risks of such offences are particularly relevant in mergers and acquisitions (M&A) transactions, during which a change of ownership takes place. The buyer / investor should pay particular attention not only to the financial statements and data, formal and legal documents, financial projects and development prospects, but also consider an in-depth analysis in terms of fraudulent activity called forensic due diligence.
What is forensic due diligence?
Forensic due diligence is the examination of an organisation and its assets for potential warning signs of fraudulent activity. It can be conducted before, during and after an M&A transaction and involves identifying potential threats and criminal activities designed to conceal the true state of the company, its business model or financial performance, and consequently its valuation. The primary objective of the review is to assess potential future impairment resulting from the target's improper or unethical business practices.
Forensic due diligence includes forensic interviewing and extensive structured and unstructured data examination. An organisation's documents and data are analysed and examined at the transaction level to identify potential warning signs, such as suspicious transactions or incomplete or falsified documentation.
While most investors conduct financial and legal due diligence, forensic investigation and forensic analysis are much less common. Failure to conduct in-depth forensic analysis can result in financial losses, as well as other risks, as some risks may go undetected.
In general, forensic due diligence aims to verify the following areas:
Authenticity of reported financial data;
The existence and background of key suppliers, employees and customers;
Adverse issues relating to owners, board of directors or key management;
Political affiliations and their possible impact on business operations;
Undisclosed related parties and transactions;
Undisclosed liabilities or potential claims and litigation;
Exposure to bribery and corruption.
While financial due diligence, a critical stage of any transaction, gives the investor a broad overview of the trends and sustainability of the company based on a macro-level data set, forensic due diligence delves into transaction-level data to find anomalies and irregularities.
Forensic due diligence includes, among other things:
identification of revenue streams or supplies that may be fraudulent or based on corruption;
identification of transactions and business events that do not comply with anti-money laundering and counter-terrorist financing regulations;
identifying transactions and business events that may give rise to potential exposure to criminal proceedings, regulatory fines, civil litigation or criminal consequences.
During pre-acquisition and pre-investment forensic due diligence, a number of areas of business risk can be reviewed to minimise the potential loss of value to the buyer post-transaction. Without a proper review, the buyer/investor is exposed to risks that are difficult to detect, such as:
fraud and data falsification,
bribery and corruption
money laundering;
Related party transactions and conflicts of interest;
other improper or illegal business practices.
An acquirer or investor may face reduced revenues, increased costs, reputational damage, litigation with competitors or shareholders and even regulatory sanctions, including criminal prosecution.
Conducting forensic due diligence requires global knowledge of fraud and corruption trends and highly specialised investigative and industry experience.
The role of forensic due diligence in business transactions
Mergers and acquisitions (M&A): In M&A transactions, forensic due diligence helps buyers identify potential issues that may affect the value or integration of the target company. This process can reveal hidden liabilities, irregularities or undisclosed risks that may affect the purchase price and deal structure.
Private equity investment: private equity firms often use due diligence to assess the financial and operational health of potential portfolio companies. This process helps to make informed investment decisions and optimise the company's post-acquisition performance.
Financing transactions: Prior to providing financing or entering into financing agreements, lenders and creditors may conduct forensic due diligence to assess the creditworthiness and risk profile of the borrower.
Anti-corruption and compliance: Companies engaging in international business transactions must ensure compliance with anti-corruption legislation, such as the US Foreign Corrupt Practices Act (FCPA) or the UK Bribery Act. Forensic due diligence is essential to identify corruption risks and ensure compliance with legal standards.
Litigation and dispute resolution: Forensic due diligence can be invaluable in litigation, helping legal teams gather evidence, assess the financial position of the opposing party and identify potential weaknesses in their case.
What are the benefits of conducting forensic due diligence prior to an M&A transaction?
Obtaining verification that the target company is involved in illegal activities such as bribery, corruption, money laundering or data falsification can bring the following benefits to the buyer/investor:
waiver of the purchase or acquisition transaction;
reduction of the purchase price of the company;
reduced risk of criminal and civil proceedings;
reduction of future reputational damage;
exclusion of liability during the negotiation stage of the company purchase agreement and receipt of appropriate guarantees from the seller.
Use of the SECUDO Virtual Data Room in the forensic due diligence process
Virtual Data Room SECUDO is a specialised and advanced tool, prepared for confidential and fully controlled sharing of data and documents. It is extremely useful for due diligence processes that require high confidentiality as well as appropriate document, user and privilege management.
Virtual Data Rooms (VDRs) play a significant role in the field of forensic investigations, especially when it comes to digital forensics and e-discovery. Here is how VDRs are used in forensic investigations:
Secure data storage and access: VDRs provide a secure and controlled environment for storing and accessing sensitive data. In forensic investigations, this is critical to protecting the integrity of evidence and maintaining the chain of custody. Access to data in a VDR is typically restricted, logged and controlled, ensuring that only authorised personnel can view or modify information.
Document retention: Investigators often need to collect and store electronic evidence, including documents, emails and other digital files. VDRs are used to store and preserve this evidence in a tamper-evident and organised manner, making it admissible in court.
Collaboration: VDRs facilitate collaboration between forensic teams, lawyers and other stakeholders. Investigators can work on the same platform, share findings and communicate securely. This helps to streamline the investigative process and ensure that all parties involved have access to the necessary information.
Version control: In forensic investigations, it is crucial to keep accurate records of document versions and changes. VDRs often include version control features that ensure that investigators can track the evolution of documents and data over time.
Search: VDRs are equipped with advanced search tools that are crucial in forensic investigations. Investigators can quickly search for specific keywords, phrases or patterns in vast amounts of data, making it easier to find relevant evidence.
Audit trails: VDRs maintain detailed audit trails that record all activities on the system, including who accessed what, when they accessed it and any changes made. This audit trail can be crucial in establishing authenticity and chain of custody.
Secure data sharing: Forensic investigations often involve sharing evidence and findings with law enforcement, legal teams and other stakeholders. VDRs offer secure methods of sharing data and documents, ensuring that confidential information is protected during an investigation.
Data integrity: VDRs use encryption and other security measures to ensure the integrity of stored data. This is critical to maintaining the accuracy and reliability of digital evidence.
Regulatory compliance: Many forensic investigations are subject to legal and regulatory requirements. VDRs can help ensure investigations comply with these requirements by providing a secure and organised environment for data management.
Reporting and documentation: VDRs can generate reports and documentation that can be crucial for presenting findings in court. These reports often include a detailed record of all actions taken during the investigation.
In summary, virtual data rooms are invaluable tools in forensic investigations, especially in cases involving digital evidence. They provide a secure, structured and collaborative environment to manage and store data, ensuring the integrity and admissibility of evidence in court proceedings.
About us
DealDone is a specialised company offering high quality information and data security products. We offer digitisation services and software in the field of modern technologies for the circulation of confidential information, classified information, sensitive data and the digitisation, security, encryption and sharing ofdata and documents inside and outside the organisation.
For more than 10 years, DealDone has specialised in providing solutions related to the digitisation, archiving and sharing of documents in the form of Document Management System (DMS) or Virtual Data Room (VDR). The company has independently developed and marketed the SECUDO VDR system. SECUDO is a platform for secure digitisation, archiving, sharing and processing of corporate documents and data offered in the cloud, in a Software-as-a-service model, for business customers.
DealDone also owns the portals www.platformainwestora.pl and www.sprzedamfirme.com, through which it supports transaction processesrelated to selling a company, raising capital and finding investors for a project.