What you should know about due diligence

Grant McCall, Director and Commercial Corporate solicitor at AMD Solicitors, outlines the importance of conducting due diligence on a target business when considering whether to invest or buy shares in the business.

What is ‘due diligence’

Anyone investing in or buying shares in a business should raise legal, financial and commercial due diligence enquiries. Due diligence is the process by which proposed investors or buyers investigate the target company’s constitutional documents, accounts, key client and supplier contracts, assets, intellectual property rights, employees, property and premises, disputes and tax history. Every individual investor has their own attitude to risk but most will raise at least some due diligence enquiries before investing.

Why we have due diligence

In simple terms, the principle of ‘caveat emptor’ applies, which roughly translates to ‘let the buyer beware’. A seller is generally not under any obligation to disclose any issues relating to the business and it is the buyer’s responsibility to raise enquiries. The process should be commenced at the earliest opportunity and before exchange of contracts or completion of a purchase.

Benefits of due diligence

The due diligence process allows a buyer to better understand the business they are buying into and learn whether the price they have offered is a fair price. If the due diligence process is carried out early on then, if any serious issues are discovered, the buyer may be able to negotiate a discount on the purchase price. Alternatively, the buyer may be able to seek warranties and indemnities from the seller which, in effect, gives the buyer a right to claim a portion of the purchase price back if any of the anticipated problems actually materialise.

A well organised due diligence process also allows the parties to communicate on any problems in the business and plan for the future which is particularly important if the parties intend to form a relationship for the longer term, eg where two companies merge together.

Costs of due diligence

There are professional costs involved in this process and input is often required at least from legal advisors and accountants. The cost is often justified as the risks associated with not investigating the target company can have very serious financial consequences.  Without carrying out due diligence, a buyer is accepting risk and may be left without a remedy if problems later arise. Parties can decide between themselves who absorbs the cost of the effort but it is normally at the buyer’s cost.

What to expect

A buyer’s solicitors will raise a detailed list of enquiries known as the due diligence questionnaire seeking written replies of the seller and copies of key documents.

In general terms, a buyer should raise enquiries on the following:

  • Corporate information – company structure and any subsidiaries, shareholders, option holders and directors;
  • Business and assets – business plan, key assets and equipment, material contracts with customers and suppliers
  • Human resources – employees, employment contracts, directors’ contracts, salaries and wages, handbooks, disputes, pensions
  • Property – properties owned, leased or occupied by the business
  • Information Technology and Intellectual Property – software and equipment used, maintenance and support contracts, intellectual property (IP) used or owned by the company
  • Data protection – how data is stored, safeguarded and used, privacy policies and GDPR compliance
  • Litigation and regulatory – any disputes the company is involved in or likely to begin, and any licenses or regulatory consents
  • Health and safety – any relevant policies, log of incidents
  • Insurance – claims history, insurance policies, premiums
  • Financial – accounts, assessment of tax liabilities, loans, charges and borrowing, VAT

Due diligence and mergers & acquisitions

Quite often with same or complementary sector mergers, a broker will put parties in touch and negotiations will commence for a merger. Both parties to the merger will undertake due diligence on the other but with one eye on how the strategies or each company will work together post completion. Key concerns for each party may be:

  • Why the owner is selling or looking to merge;
  • What the company goals are and if they are a strategic fit;
  • Merger history, including whether the company has recently acquired other companies;
  • Questions about the financial statements;
  • If the company can afford the transactional expenses of the deal; and
  • What the benefits are to the buyer of involving themselves with the company.

Due diligence on a merger is of heightened importance as a new management team may be formed, office moves may be needed, employment terms may be reviewed over time, contracts and banking requirements may change, all at a time where service levels will need to remain constant amid the changes.   

Gearing for due diligence

For a selling company, keeping clear records is essential. A buyer may reduce their offer or withdraw from negotiations altogether if the seller cannot provide satisfactory replies to due diligence enquiries. For a buyer, they will need a strong professional team around them to guide them through the process and advise them at every stage of the purchase.

Another important factor is time. If the seller cannot respond to due diligence enquiries in a timely or orderly fashion, the buyer may lose interest. From the seller’s perspective time is often critical; the quicker the deal can be done the better chance it has to complete. A buyer may keep their options open until the negotiations are further along and, if the seller drags its feet in the due diligence process, the buyer may be tempted to walk away altogether.   

At AMD Solicitors, our experienced team can guide you through the due diligence process and ensure you are advised on negotiations for the business you trying to buy or sell. Our expert team of solicitors in Bristol can provide guidance and assistance with the entire process. For more information on how AMD solicitors can help your business simply call our team on 0117 973 3989 or email Grant McCall at grantmccall@amdsolicitors.com.

This article is provided for general information purposes only and represents our understanding of the relevant law and practice as at the date of uploading. This article should not be relied upon as legal advice pertaining to any specific factual situation. Legal decisions should be made only after proper consultation with a legal professional of your choosing.

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