Due Diligence when buying a business – the legal perspective
This is an investigative process where the buyer will seek information about the business and the seller to ensure that what he believes he is purchasing in the transaction is actually the case.
Throughout this process, the buyer will have access to information and documentation from the seller relating to their business.
It is essentially an exercise for the buyer to investigate the key aspects of the business. Generally the due diligence exercise commences with the seller filling out a questionnaire supplied by the buyer which will request documents and focus on the areas of the business. The seller’s answers will start to form the basis of the buyer’s warranties and indemnities.
The due diligence exercise can be fairly lengthy and should not be left until too late in the transaction. The Heads of Agreement should be signed before due diligence is commenced and, ideally, the seller should not provide the buyer with any documentation until a confidentiality agreement is in place.
Prospective buyers should take the advice of investigating accounts to help determine whether their valuation of the company is correct. The due diligence process will generally place either the buyer or seller in a strong bargaining position depending on what is discovered.
Below is a non-exhaustive list of what information is required in a due diligence exercise:
It is necessary for the buyer to undergo diligent investigations of the property involved in the transaction. This will entail property searches and a review of the official titles of the property. These investigations may uncover issues such as easements and covenants which may have to be dealt with.
Planning permission will have to be reviewed on the properties involved in the transaction.
As with any property transaction it is good practice to instruct surveyors to investigate and place a value on the property. It is common for a property to be the largest asset owned by a Company which makes it good practice to ensure that it is in good condition as the value of the property may greatly affect the potential value of the transaction.
If the property is leasehold, the lease should be investigated to ensure that the terms will be favourable to the buyer.
It will be crucial to investigate the customers of the business. Especially important for the buyer will be to uncover who the main customers who make up the core of the revenue coming into the company are. It is common for contracts to include a clause which deals with a situation in which the Company changes ownership; this will need to be investigated as it may force a change to the structure of the deal or an approach to the customer.
A thorough report will need to be compiled on the employees of the Company and their respective employment contracts. If the structure of the deal is to be an asset sale then TUPE regulations may come into force which will be something to consider for the prospective buyer.
Contracts of Employment
It is unlikely that the prospective buyer will want to hand new long term contracts to employees before entering the business and having a chance to evaluate their skills.
It is fairly common when a Company is purchased for the new buyers to want to streamline and make the Company more efficient. One of the main ways in which buyers will look to do this will be by restructuring the staff of the Company. All redundancy costs should be figured into calculations before the transaction is completed. Buyers will also have to abide by the strict redundancy procedures which are necessary for the Company to undertake.
One of the most important assets of a Company is their intellectual property rights, which can take the form of copyright, trademark, design rights and/or patents.
Their validity and any doubts as to their ownership must be investigated, particularly if any such rights have been registered. Increasingly, the wealth of a business is reflected in such “intangibles”.
It is recommended that prior to purchasing a business; a valuation of any pension funds which may be held by the business is undertaken. A pension fund may become a big liability to a purchaser once the transaction is complete.
It is pertinent that any potential buyer investigates whether the business is subject to any litigation. The buyer will not want to purchase a business and then be tied up in lengthy litigation which could end up being a big liability to the business.
The due diligence exercise will investigate all aspects of the business including any litigation disputes or claims which may arise. A thorough due diligence exercise will limit the amount of liabilities which could surprise a potential purchaser of a business on completion.