Corporate Due Diligence: A Bite-Sized Guide

Corporate Due Diligence: A Bite-Sized Guide

As anyone who has bought or sold a business will attest, there are myriad steps to the process. But the due diligence exercise is arguably the most important – and the most time-consuming. If you’re tempted to rush through this process, the oft-quoted Forbes statistic is worth bearing in mind: that around 50% of deals fall through at due diligence.

What is due diligence?

When a buyer is planning to purchase a business or the shares in a company, they need to understand the value and commercial potential of the target. Due diligence is the process by which the buyer investigates the potential acquisition in terms of its finances, operations, systems and processes, contracts, licences and IP rights, property assets, workforce, commercial position and regulatory compliance. The exercise allows the buyer to thoroughly investigate the target business, flagging any potential issues early in the transaction lifecycle.

It can be a lengthy process, but is absolutely essential to a potential buyer.

The target business will wish to avoid a situation where a buyer discovers unanticipated risks, liabilities or facts that lead them to try and reduce the purchase price. But equally, the process can protect the seller, because if any areas of concern are identified, they can take action to mitigate or resolve these risks before the transaction is completed.

Due diligence: fast facts

How does the process work?

The nature and extent of due diligence can vary and depends on the circumstances of the transaction. For example, the number of due diligence questions asked will generally be a lot longer where the transaction is complex or of a high value. On the other hand, where the value is smaller or the buyer already has a good grasp of how the business operates, they may elect to issue a more streamlined due diligence process.

Considering the above, it is difficult to put an average timeframe on the due diligence, as it will very much depend on the nature of the deal. No due diligence questionnaire will be the same as another, and each will also be tailored to the industry of the business or company being acquired.

Risk mitigation

Thorough due diligence will identify liabilities and legal risks associated with a business. The buyer is relying on the due diligence process to ensure that risks are identified in good time.

Drafting contracts

Awareness of potential risks and liabilities associated with a business will help the legal team create contracts that safeguard the client’s interests. Specific warranties and indemnities will be placed into the sale agreement to protect the buyer against any risks identified in the due diligence.

Compliance

Detailed due diligence will uncover any gaps in legal and regulatory compliance and reduce any associated risks.

The onus is often on the buyer’s solicitors to initiate the process by providing the seller’s solicitors with a due diligence questionnaire.

The seller will begin to collate their documents and responses to the questionnaire, storing the information in a secure online “data room” only accessible by the parties and their advisers. The number of documents likely to be requested means that the seller must be well organised to avoid delaying the due diligence process.

Among the many documents the seller may be required to provide are:

• accounts;
• details and full copies of all commercial contracts relating to the business (these might include third-party supplier contracts);
• employment contracts and agreements for any self-employed persons. These commonly outline details of salaries, years of service and working hours;
• details of whether the property is owned or occupied;
• copies of any leases, planning permissions and risk assessments in connection with a property (for example, fire risk assessments, legionella reports, asbestos, and so on);
• an inventory of all fixtures and fittings included in the sale;
• an inventory of all equipment, including details of any hire agreements and maintenance contacts;
• details of any customer complaints, disputes, or litigation;
• copies of all appropriate insurance policies relating to the business, including building, employer’s liability and public liability, as well as professional indemnity certificates for staff (if applicable); and
• where applicable, a full copy and details of any registrations and certificates demonstrating compliance with the relevant regulatory bodies.

This list is certainly not exhaustive and will vary according to the sector and the buyer’s needs and the business or company being acquired.  

Following disclosure of the initial due diligence documents, a due diligence report is usually drafted by the buyer’s solicitors and sent exclusively to the buyer for review. Although these reports can be weighty, it is crucial for buyers to read them properly. The buyer’s solicitors will highlight any issues contained within, which often form the basis of any additional enquiries that are subsequently raised by the buyer and their legal team.

If the buyer finds any aspects of the provided material concerning, or if key issues are discovered during the due diligence review, they may pursue a reduction in the purchase price or seek to obtain further protection in the sale agreement in the form of warranties or indemnities. If these issues are extreme, the buyer may abandon the purchase altogether.

We have put together a list of top tips to help businesses on either side of the transaction to avoid this potentially costly worst-case scenario:

1. For sellers: consider when the staff will be told about the proposed transaction and who will be on hand to assist with document collection.

• For sellers: start collating or locating the various types of documents outlined above that will more likely than not be requested – accounts, employment agreements, etc.

• For buyers: provide full responses to the due diligence. While it may be more work initially, it will mitigate the chances of follow-up questions from the buyer.

• Documents should be redacted where appropriate to ensure compliance with data protection legislation.

• Be prepared for follow-up due diligence questions to be asked by the buyer’s solicitors.

• Line up your accountant in preparation, as their input will likely be required on the accounting and taxation questions.

If you are considering selling or buying a business, contact our Acuity Law Corporate team to ensure your business is fully prepared and protected.