Acquiring another business is a huge step for any organisation; it is an exciting opportunity for growth, but also one which hides many pitfalls for the unwary.

Due diligence is a vital component of making your merger or acquisition a success. Carried out correctly, due diligence can provide you with a complete understanding of the business you are taking on, allowing you to identify issues and act accordingly.

What is due diligence?

Due diligence is the process of investigating and discovering detailed information about the business you wish to acquire. It involves looking at various aspects of the business and building up your own unvarnished picture of what the acquisition will entail.

A business’s assets and existing commercial relationships are usually where the perceived value lies in an acquisition, but it is important to remember that acquisition also means taking on the debts and liabilities of the business as well.

The benefits

Thorough due diligence can help in many ways; it can:

• Verify whether information you’ve been given is accurate.
• Uncover hidden problems with the business, such as debts, legal disputes, and tax problems. This helps you to know exactly what you are taking on, and it may also uncover ‘red flags’ or fundamental issues that mean you no longer wish to proceed with the acquisition.
• Provide a clear, holistic indication of the value of the business. This can improve your negotiating position if there are aspects which undermine the value.
• Inform the terms of the Share Purchase Agreement or Asset Purchase Agreement. You and your legal advisers can adapt the purchase terms to include protections against risks that have been discovered.

What does due diligence involve?

Due diligence can focus on various areas of a business. However, two crucial areas are:

• Legal due diligence – this will involve checking details such as:
  • Ownership arrangements of the company (making sure the seller is legally entitled to sell the shares or assets being acquired)
  • The company structure
  • Shareholder agreements
  • The terms of important contracts with suppliers and customers (making sure that these are transferable to your organisation)
  • Whether there are any ongoing or past legal disputes or regulatory/compliance risks
  • Employment contracts, policies, and arrangements
  • Intellectual property rights
• Financial due diligence – including checks on:
  • The current financial situation
  • Previously filed accounts
  • Debts and liabilities
  • Tax compliance history, including corporation tax, PAYE for employees, and VAT

In addition, comprehensive due diligence will often involve checks in other areas. These may include:

• Asset due diligence – for example, checking legal arrangements on business premises and how they are held and checking the condition of equipment and plant.
• Operational due diligence – understanding how the business works on a daily basis.
• Commercial due diligence – investigating the commercial landscape in which the business operates, for example assessing its competition, trends in the market, and growth opportunities.

Why is due diligence so important in a business acquisition?

In any acquisition or merger, the duty is on the buyer to investigate the particulars of what they are buying. This is the principle of caveat emptor – ‘let the buyer beware’. It means that, though the seller must be truthful in the information they provide, they are not legally obliged to set out all of the potential issues the buyer might encounter with what they are selling.

This makes it critical for a buyer to uncover these problems themselves – through due diligence.

As mentioned above, thorough due diligence can bring other benefits to your negotiating position, and can allow you to resolve or mitigate issues before the acquisition. This could be through reducing the purchase price, adding warranties and/or indemnities to the purchase agreement, or asking the seller to take action themselves to remove the issues.

Instructing solicitors to help with your due diligence

Due diligence can be labour-intensive, and may take a considerable amount of time and resources to complete thoroughly. Instructing expert solicitors with experience in mergers, sales and acquisitions can ease the burden and provide your business with invaluable legal guidance.

If possible, it is best to instruct your solicitors as early in the process as you can, so that they are in place and focused on protecting your business interests from the outset.

It may also be helpful to highlight to your solicitors some of the key reasons why you wish to acquire the business. Doing so will give your legal team an understanding of the aspects you view as critical to the acquisition and so, if issues are discovered in these areas through the due diligence process, priority can be given to finding solutions, or the purchase can be cancelled without unnecessary loss of time.

If you would like to speak to Bridge McFarland’s specialist corporate solicitors, please contact us today.