The “Due Diligence” Process
The first step in any business or practice purchase after heads of terms have been agreed, is to carry out the “due diligence” process. This will involve legal and financial due diligence in every case and in larger transaction may involve separate commercial, IT, technical, IP and insurance due diligence from specialists in the respective fields.
Why do we do due diligence?
The due diligence exercise is carried out to provide the buyer with as much information as possible, so that they gain a fundamental understanding of the business they are buying. This would include how it operates, its key contracts, its financial performance and where its strengths and weaknesses lie. Where any risks are identified, we look at ways of providing the buyer with protection in the sale and purchase agreement (the written agreement recording the commercial terms of the transaction). In essence, it is about being diligent. Properly executed, it is a way of reducing any surprises, nasty or otherwise, following completion of the purchase.
What does the legal due diligence process involve?
The legal due diligence process typically involves the buyer’s solicitors providing a detailed questionnaire, containing questions about the business being purchased to the seller’s solicitors for completion by the seller. These questions will cover legal, commercial (what contracts the business has – with customers and providers), financial and tax matters. Factors such as the size of the business, or the level of risk associated with the nature of the business will affect the extent of the due diligence exercise and also the types of queries that are raised.
In reply to the due diligence queries, written answers are usually provided along with appropriate supporting documentation. This documentation is collated by the seller and reviewed by both the seller’s and buyer’s solicitors. The buyer’s solicitors will then consider whether they are satisfied with the responses or whether they want additional information. Additional enquiries will be raised until the buyer’s solicitor and the buyer are content that all the questions have been adequately answered.
How is the information that is obtained used?
Some of the information goes to confirm that the business’ affairs are as anticipated. If certain matters come to light, against which the buyer needs to be protected, provision can be made in the sale and purchase agreement. This would include the inclusion of appropriate warranties (or written guarantees) and indemnities (clauses which offer protection against financial loss should certain circumstances arise or exist in future). The buyer’s and seller’s solicitors will negotiate these warranties.
The due diligence process is a vital part of the transaction. When acting for a seller, we assist and advise on the collation of the documentation, and thoroughly review the enquiry responses, to ensure all is correct. When acting for a buyer, we carefully scrutinise all the information so that the buyer has a clear and complete picture of the business that they are acquiring.
If you are thinking of buying or selling a business, give us a call on 0117 926 4121 to discuss.