Buying or selling a business may be an exciting time, but no buyer is going to enter into a transaction without doing their homework. That homework comes in the form of the due diligence process.
What needs to be done?
In a nutshell, due diligence is the buyer collecting information about the target company. Most of this information comes through direct questioning of the seller.
As part of the sale process, most sellers will have put together some basic information, such as the accounts, in a pack to provide to any potential buyer. But this is rarely enough to re-assure an astute purchaser, so what needs to be done?
Essentially, there are three main types of due diligence:
Depending on the area of business the target company is involved in, there may be other types of due diligence (such as environmental), but usually these will be undertaken as part of the above.
Business due diligence is usually undertaken by the purchaser and looks at matters such as the state of the market the target company operates in, future potential, and whether the company is a ‘good fit’ with their current operations.
Financial due diligence is usually undertaken by accountants instructed by the buyer, who may produce a report. They will look in to the financial affairs of the target company and highlight any risks. Financial due diligence can help with ascertaining and negotiating a price for the company, and advising one best structure for financing the deal.
Legal due diligence is usually undertaken between the buyer and seller’s solicitors. It covers a multitude of areas including:
- the ownership and structure of the target company or group;
- the current employees and legal rights;
- loans and financing;
- the property held by the company;
- transfer of company assets and contracts.
As such the scope is very wide, and often overlaps with the business and financial due diligence. For this reason, all types of due diligence must be viewed together to build a complete picture of the target company.
How is Due Diligence Done?
Legal due diligence is usually undertaken by the seller replying to a set of questions posed by the buyer’s solicitors and providing any corresponding documents; a process known as disclosure.
Disclosure is not just a one off procedure; it is usual for the replies to raise further questions which need to be answered. The number of documents which need to be disclosed, investigated and dealt with can be huge, such as contracts of employment, property deeds, contracts entered into with suppliers and customers etc. For this reason, undertaking legal due diligence is not a quick process.
Why Do Due Diligence?
From a buyer’s perspective, it is obvious why due diligence needs to be undertaken; they need to protect their investment and ensure they are not being sold a pup.
A seller’s motivation is perhaps not so clear. Misrepresentation aside, under English law the principle of ‘buyer beware’ (caveat emptor) applies, so why should the seller take part in disclosure?
Firstly, if a seller refuses to take part, they are likely to lose the sale – or at least devalue the company in the eyes of the buyer.
Secondly, a buyer will protect themselves in the sale contract using warranties. If the seller reveals more about the company, they are less likely to find themselves liable to compensate the buyer under the warranties. That is why the seller must take part – and take part fully – in the due diligence process.
When looking to buy a business, it is important to obtain comprehensive legal advice before entering into any agreements. Our corporate team is able to advise on all legal aspects of business acquisitions and disposals and guide you through the process. Please call for a free, no obligation consultation to discuss how we can help.
The content of this blog does not constitute legal advice and should not be considered to be the same. Should you wish to obtain formal advice in this matter, please contact a member of the Corporate/Commercial team on 0330 024 9643.