In her first article, new member to the Corporate & Commercial Team Hem Gujadhur outlines some of the most important questions that should be asked during due diligence.
What is due diligence?
Due diligence is the process of examining all aspects of a company or business (often referred to as the ‘target’), before potentially purchasing it.
A specialist usually covers each area to be investigated, be it legal, financial or tax, and prepares a report on its findings.
This article will focus primarily on legal due diligence.
Why is legal due diligence important?
There is no duty on the seller to disclose all liabilities and issues in relation to the target, unless they are required to give a warranty in relation to such liabilities or issues.
Therefore, it is particularly important for the buyer to undertake legal due diligence to understand what they are buying and whether there is ‘value for money’.
When should due diligence be carried out?
Once heads of terms and confidentiality agreements have been signed, legal due diligence should be conducted.
Legal due diligence can sometimes be quite an intense process where a large amount of information is provided by the seller and subsequently reviewed by the buyer.
Quite often, data rooms will be used to make the sharing of information more efficient.
The due diligence process usually runs concurrently whilst negotiations of the sale are ongoing.
What if the due diligence raises concerns?
If the legal due diligence report highlights certain areas of concern, the buyer may choose to renegotiate with the seller on key elements of the deal, such as the purchase price.
The buyer may also seek specific indemnities from the seller in respect of any areas which could expose the buyer to potential future risk.
How is legal due diligence carried out?
The first step in undertaking legal due diligence is to evaluate the deal – a preliminary assessment is made of the main risks and future opportunities.
A detailed set of enquiries, covering both standard and more bespoke questions, is then submitted to the seller.
Hem Gujadhur, Corporate & Commercial Paralegal, says “There are many areas of legal due diligence that should be high on the prospective buyer’s list.
These include - employment terms, pensions, any outstanding litigation, major contracts, IT systems, intellectual property rights and many more.
These provide a full picture of what is being purchased.”
What should be included in legal due diligence?
When conducting legal due diligence, the legal adviser will also focus on key points such as:
- How good the seller’s title is;
- The target’s contracts, especially change of control clauses and consent requirements from third parties;
- Finances and securities (registered and unregistered); and
- Periodic checks at Companies House, the Insolvency and Companies List and Land Registry.
This is only a snapshot of things considered when performing legal due diligence.
Bear in mind that transparency is a must and too many unknowns could increase the buyer’s future risk.
What risks should be assessed in legal due diligence?
Risk cannot be eliminated entirely, but it can be mitigated.
For the buyer, risk assessment is all about asking the right questions and knowing where the right places are to look, which should be facilitated by the seller.
A prospective buyer should ascertain:
- How good the cash flow situation is;
- Whether there are any hidden liabilities;
- If key employees will be staying in the target;
- Whether company books/records are up-to-date;
- That any leases on premises are in order and have not yet expired; and
- What insurance policies are in place.
How long does legal due diligence take?
It should be emphasised that legal due diligence is only one of the various types of due diligence undertaken.
Since due diligence is a vital step in any sale transaction, it should therefore be conducted thoroughly within a specified time frame.
The length of time dedicated to this process will depend largely on the complexity of the transaction, cost constraints and the completion deadline.
It will also depend on the material issues which arise from the investigations and whether further due diligence is required.
What comes after due diligence?
Once due diligence covering all the aspects of the target has concluded and each party is satisfied with the outcome, the buyer will then have a draft acquisition agreement prepared, to be reviewed by the seller.
Findings from the due diligence report will undoubtedly be factored in as required.
Advice for prospective buyers
To conclude, due diligence, in particular, legal due diligence, is crucial from a buyer’s perspective before proceeding further in a sale transaction.
Therefore, if you are a prospective buyer and do not want to be caught out by the maxim ‘caveat emptor’ (buyer beware), please contact our Corporate and Commercial team who will be happy to assist you with your due diligence queries.
Read what makes a strong commercial contract here.
More Advice
My colleague Karen Edwards has written a whole series on advice for businesses. I've provided links to a couple of these articles below that I think might interest you:
- What is a shareholders agreement and what should it include?
- Franchising: Pros, cons and our advice
- Purchasing a franchise
Corporate & Commercial Solicitors
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