Due diligence is a vital process that you need to go through to check the financial position and viability of a business you are proposing to buy. It is also something that should be done when awarding contracts or agreeing to extend credit facilities.
Nick Guinness, commercial lawyer with Forrester Sylvester Mackett explains the basics.
‘Due diligence allows you to examine a business’s records and to ask questions about financial performance, assets and liabilities, current activities and work in the pipeline so that you can determine credit worthiness, commercial potential and overall viability’, explains Nick Guinness.
‘It is not a process that focuses solely on accounts; it also considers business structure, organisation and performance of the current management team, employee numbers and personnel matters, terms and conditions of trading, supplier contracts and other key legal documents.’
‘In the context of a business acquisition, carrying out due diligence enables you to determine whether the proposed purchase price is fair and realistic and whether there are any areas of concern that require further consideration or investigation before the sale proceeds.’
The due diligence process explained
The first step in the due diligence process is to make pre-contract enquiries via a list of questions and requests for documents prepared by your solicitor. The enquiries will be tailored to your circumstances, but typical requests include disclosure of:
- business information, such as structure details and, in the context of a company, shareholder and directors’ lists, company memorandum and articles of association;
- a list of business assets, including key contracts with customers and suppliers;
- a copy of any business plan(s) that have been made;
- details of any freehold or leasehold property owned or occupied by the business;
- a list of personnel (employees and directors) and details of any pension plans;
- any intellectual property owned or used by the business;
- details of how personal data is used and stored, and the steps taken to ensure compliance with data protection laws;
- any regulatory requirements or ongoing and anticipated litigation;
- all insurance policies, together with details of any actual or prospective claims;
- all health and safety policies; and
- confirmation that all known tax and VAT liabilities have been settled.
As Nick Guinness explains:
‘It is vital that due diligence is conducted thoroughly and that the information obtained is examined in detail to ascertain what else may be required to get a full picture of what is going on.’
What if you identify a problem?
If a problem is identified by your solicitor, this will be brought to your attention as soon as possible. Problems spotted by the seller and their advisor should also be notified to you.
Depending on the nature of the problem, it may be addressed by the seller providing you with written assurances that if a problem arises they will accept responsibility and deal with it. For example, the seller could be asked to provide a warranty confirming the existence of intellectual property rights which would entitle you to walk away from the deal or to claim compensation if those rights were found not to exist. They could also be asked to provide an insurance-backed indemnity in respect of unpaid tax liabilities, giving you reassurance that any outstanding amounts would be settled by them not you.
Your rights where information is withheld
The seller should provide answers to all pre-contract enquiries and supply any documentation requested. However, there is no general contractual obligation on them to make voluntary disclosures of information, particularly in respect of matters they consider would not (if they were disclosed) contradict or distort any other information provided that is relevant to the acquisition.
Using a solicitor who understands the due diligence process, and the type of business you want to buy, is the key to ensuring that the fullest possible disclosure of information is obtained. They will also be able to advise you on the steps you can take, once the deal has completed, if it turns out that anything the seller or their advisors have told you is incorrect or if important information was withheld. This may include bringing a compensation claim for breach of contract or misrepresentation.
For advice on business acquisitions, or any other commercial law matter, please contact Nick Guinness on 01225 755621.