Last week, we detailed topics related to patents and inventions, which are of critical importance for entrepreneurs in protecting intellectual property. This week, we will focus on the “Due Diligence” process, which plays a central role in evaluating legal and commercial risks frequently encountered in business relations by entrepreneurs and investors.
Due Diligence is a comprehensive examination of the legal, financial, and operational status of a company or project. This process involves meticulously analyzing various documents, contracts, reports, and legal obligations to identify potential risks and opportunities. We can summarize the purpose of Due Diligence as eliminating information gaps for the parties involved and ensuring that agreements are based on solid legal and commercial foundations. Considering that mergers and acquisitions have become common practices in today’s Turkey, the preparation process conducted before the signing of the main contract in such procedures is of great importance.
The “Due Diligence” phase, briefly defined below, not only arises during mergers and acquisitions but also appears when investments are being made in startup companies. Although Due Diligence is not a regulated process in our legislation, it is a phase carried out in practice for all mergers, acquisitions, and investment transactions. In the context of mergers, acquisitions, or investments, Due Diligence refers to the detailed and systematic examination of the general status of the target company or startup before these transactions are conducted. In academic studies in Turkish, Due Diligence is translated as “inspection procedure” or “situation analysis.”
If we summarize the preparation process under three main headings:
- Letter of Intent: The Letter of Intent is a preliminary protocol that outlines the general terms of the collaboration or agreement between two parties. In Turkish Law, this document does not create a binding obligation between the parties, but it officially expresses the main framework of the agreement and the intentions of the parties. The Letter of Intent sets the foundation for the future contract and defines the expectations of the parties and the start of the negotiation process.
- Confidentiality Agreement (Non-Disclosure Agreement – NDA): A Confidentiality Agreement is a legal contract aimed at protecting sensitive information shared between parties. Within the framework of the Turkish Commercial Code and the Turkish Code of Obligations, this agreement aims to prevent risks such as unauthorized disclosure and use of the information. The Confidentiality Agreement strengthens trust between the parties by ensuring that the information is kept confidential and clarifies the boundaries of information sharing.
- Due Diligence (Comprehensive Examination): In Turkish Law, Due Diligence generally refers to the comprehensive analysis of the legal, financial, and operational status of companies during “Mergers and Acquisitions.” This process includes a detailed examination of all legal obligations, financial situations, and operational risks of the companies to ensure that the parties can make investment or collaboration decisions based on informed knowledge.
During the Due Diligence phase, important factors that add value to a company’s operations are identified and analyzed. The company’s market position is assessed, potential future opportunities and risks are evaluated, and strategies to improve its standing in the industry are developed.
Due Diligence can be requested by the buyer, seller, or investor. If you own a startup company, this process is usually requested by the investor in investment transactions for your company. The primary goal of Due Diligence for the buyer or investor is to evaluate the risks and liabilities related to the anticipated agreement with the target company or startup, assess whether the past financial performance of the target company or startup is sustainable, identify the liabilities of the target company or startup, minimize risks, ensure transparency of information between the parties, determine the deal price, and make an investment decision.
The scope of the Due Diligence process can be shaped by the special requests and expectations of the parties. Therefore, there is no standard application for the process, and it is customized according to the requirements of each case. However, in general, Due Diligence examination is conducted under three main headings:
- Legal Examination: This category involves a comprehensive evaluation of the company’s legal status, current and potential legal risks, contracts, and compliance. It also includes compliance with sectoral and industrial legal regulations.
- Financial Examination: This section reviews the company’s financial statements, financial performance, tax obligations, and other financial risks. While evaluating financial health and sustainability, it covers subtopics such as industry financial standards and tax liabilities.
- Operational Examination: This category details the company’s operational processes, occupational safety, environmental standards, information systems, and human resource management. It also includes sales and marketing strategies, sectoral and market analysis, among other factors.
The party requesting the Due Diligence presents its questions and requests to the other party based on the scope of the examination. Subsequently, with the help of lawyers, the other party prepares a physical or virtual “Data Room” where the necessary information and documents are made available for the requesting party to access. In brief, a Data Room can be defined as a space where the data related to the company’s responses to the requesting party’s questions are stored. Upon the examination of the information and documents by independent consultancy firms or expert individuals, a comprehensive Due Diligence report is prepared. The results of the Due Diligence report are reviewed, and the merger, acquisition, or investment processes are either continued or terminated based on these results. Additionally, in the Due Diligence process, a timeframe is usually determined based on the scope of the review, and it is essential to complete the review within this period. Another important aspect of Due Diligence processes is the provision of data flow. The data presented in the Data Room must be provided with care and professionalism. This is because the provision, management, planning, and sequencing of data are critical for evaluation and the overall process. While ensuring this data flow, preliminary preparation should be made, and it should be remembered that it will be fundamental to the process management in the merger or investment.
In conclusion, the Due Diligence process is a critical phase for both entrepreneurs and investors. It ensures that risks and opportunities are thoroughly assessed before any agreement is made. For startup companies, it is essential to always have their information and documents ready, considering that they may attract investment at any time. For investors, it is recommended to have a pre-prepared list of questions for the requested information and documents regarding the companies they wish to invest in.
In the next part of our series, we will address the regulatory approvals required during the investment process, which is another area of interest for entrepreneurs.
For detailed inquiries, please contact Gemicioğlu Law Firm.
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