The crucial role of due diligence

Buying a business or company can be a legal minefield and no element of the process is more important than due diligence. This is effectively a legal audit of the company’s affairs and is critical for identifying the extent of any assumed liabilities, allowing the buyer to assess whether the acquisition represents a sound commercial investment. If liabilities are uncovered, the buyer may decide either not to proceed or to renegotiate the terms of the acquisition.

Some buyers undertake minimal due diligence simply relying on contractual warranties or indemnities in the sale agreement.This approach is by no means fool-proof as:

• warranty claims can be difficult to prove and expensive to pursue,
• if the warranty claim goes to the goodwill or reputation of the business, the damage may not be capable of remedy, and
• the buyer may not be able to recover all of its losses as there are often limitations on the liability of the seller in relation to a breach of warranty claim, or in some cases an indemnity claim.

It is therefore preferable to identify and deal with any issues pre-completion by undertaking a comprehensive due diligence exercise. This should examine some or all of the following matters relating to the target company or business:

• the legal structure and ensuring that there is good title to the assets being sold
• previous accounts and tax affairs
• key customers, suppliers and material contracts
• consents or licences required and ensuring that these are valid
• intellectual property (IP) owned or licensed and details of any prospective or alleged infringement of that IP
• real estate owned or leased
• environmental and health and safety issues
• employees and contractors and the terms of their engagement
• pension schemes in operation
• insurance policies and claims record, and
• existing or threatened litigation/disputes

It is becoming increasingly common for the buyer and seller to use a virtual data room. This allows documentation to be uploaded and reviewed in an organised fashion, as well as helping to protect confidentiality and prevent information leaks.

The due diligence process can be an unwieldy beast and therefore it is prudent to have a good set of professional advisors on hand – solicitor, accountant and tax advisor – to ensure that the process is managed properly and efficiently, and to minimise the risk of problems further down the road.