If you don’t think due diligence is important, think again…

IF YOU DON’T THINK DUE DILIGENCE IS IMPORTANT, THINK AGAIN…

What is the purpose of due diligence?

If you are buying a business, the purpose of undertaking legal due diligence is to assess the potential risks involved by eliciting information from the seller about the business, key contracts, its assets and obligations and liabilities.

Two levels of protection for the buyer

Undertaking an appropriate level of legal due diligence on key issues that may affect the value of the business are critical, and may assist if it becomes necessary to negotiate a revised purchase price. Legal due diligence is the first of two steps that a buyer will take to protect itself against the risks associated with buying a business (where, generally, the risk of defects or liabilities is on the buyer):

• It involves the buyer obtaining as much information as possible about the business to reveal areas where there are or may be material liabilities or defects;
• Once the buyer has undertaken its legal due diligence, the buyer will want to protect itself contractually with suitable warranties and indemnities in the purchase agreement.

Warranties and Indemnities

Warranties are a contractual statements which are made by a seller detailing the condition of what a buyer will be acquiring on completion of the transaction. Warranties are designed to protect the buyer and to elicit further information about the business from the seller during the due diligence process. Warranties form part of the contract and, if proven to be untrue, the buyer will have a claim for damages against the seller for the loss it suffers.

Indemnities are suitable for known and specific risks that have been identified during the course of the legal due diligence process, and involves a promise made by the seller to reimburse the buyer in respect of a particular liability.

You can learn more about the difference between a warranty and an indemnity here.

Factors that influence the scope of legal due diligence

1. Commercial aims

The focus of the legal due diligence may be in key areas on which the buyer has placed its value on the business. For example, if the buyer’s aim is to expand its customer base into a new market, the buyer may wish to focus on existing trading contracts of the business it is proposing to acquire.

If the buyer is acquiring investment-based assets, the financial stability of the assets and how the investment may be realised will be of peak interest to the buyer.

2. Identified areas of risk

If the business operates in a regulated sector, then it may not be straightforward to obtain the necessary consents from the regulators. The buyer will want to ensure that all regulatory consents and registrations are in place at completion.

If the business is highly-leveraged, the buyer will want to scrutinise the financial facilities and any loans of the business (including why they are necessary).

3. Time constraints to meet acquisition timetable

The buyer may not be in a position to commit sufficient financial resources or manpower to a full-scale level of due diligence over the business or its assets and may seek to limit their due diligence accordingly.

4. Confidentiality

The seller will want to keep the certain information confidential e.g. from its staff members who may not be informed about the transaction until completion takes place, which may place limitations on the extent of enquiries from the buyer.

Key areas to investigate in a legal due diligence exercise

When undertaking legal due diligence, any buyer will commonly wish to scrutinise key areas of the business:

Corporate Information

The buyer will need to ensure that the seller has good title to the shares in the company (on a share sale) or the assets being sold (on an asset sale): you can find out more about the differences between a share sale vs. an asset sale here. Information on the shareholdings in a company can found at Companies House, but it should be noted that Companies House is simply a notification portal and may not represent the accurate shareholding in the company.

Commercial Contracts

The buyer is advised to check whether all contracts to which the business is a party to are vital to the well-being of the business and whether they require consent to assignment or contain other restrictions on assignment.

The buyer will also want to check whether any of the significant contracts will be affected by the change of control provisions and if any are due to expire.

Financial Information

The buyer should check for issues that require inclusion of warranties / indemnities in the sale and purchase agreement.

The buyer should check whether any charges are registered against the company and what type of security is held and whether this will be discharged on completion.

Employment

The buyer is advised to check terms of all employment contracts and in the case of an asset sale, check whether any employees are transferring over under TUPE regulations.

Property

The buyer should carry out all relevant property searches against any property to be acquired and review the necessary title entries.

Birdi & Co undertakes legal due diligence on behalf of its clients when they are buying a business. We will discuss the scope and extent of the legal due diligence that is required, and provide you with your bespoke legal due diligence report. This will give you exactly what you’re looking for, rather than a broad-brush report which is not focused to meet your particular needs.

For more information, please call us on 020 4571 8630 or email us at hello@birdilaw.com. Alternatively, please take a moment to complete our free enquiry form.

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