Due diligence is the procedure whereby a prospective buyer of, or an investor in, a company or business, investigates the records and company documentation of the target to determine whether:
1. the proposed acquisition value is correct, or whether it needs to be renegotiated;
2. there are any significant risks associated with the proposed acquisition, such as threatened or unresolved litigation;
3. there are matters on which it requires further information, and/ or which the prospective buyer should use in order to revalue the target.
In any potential acquisition the obligation is on the buyer to determine the risks associated with any potential acquisition, and the principle is encapsulated in the phrase "caveat emptor" (buyer beware).
In practice prospective buyers generally undertake financial due diligence first, in order to ensure that the potential purchase or investment is financially viable. Financial due diligence is undertaken by accountants including tax advisors.
If the financial due diligence is in line with expectation, then the buyer generally proceeds with legal and commercial due diligence, which is undertaken by corporate solicitors.
The due diligence process involves drafting and sending to the targets owners a detailed due diligence questionnaire. The questionnaire is broken down into sections, and in the case of legal due diligence, the sections relate to different legal areas, such as intellectual property and commercial aspects of the proposed acquisition.
Each section includes an exhaustive list of questions relating to the target and which are to be answered by the seller. Appropriate evidence/ documentation should also be disclosed by the seller, where appropriate.
Once the seller has responded to the due diligence questionnaire, reports from the buyers accountants and corporate solicitors are usually prepared, to record the findings of the legal and financial due diligence process.
The purpose of the due diligence process is to determine the nature of the target, and to identify any risks associated with the potential purchase of the target. The results of the due diligence process should determine whether the acquisition is viable, and whether certain aspects of the proposed acquisition should be renegotiated including the price.
The due diligence process is supported by warranties and indemnities in the acquisition agreement. Where a risk has been identified in the due diligence process, then it would be prudent for the prospective buyer to include a specific indemnity in the sale and purchase agreement, whereby the seller indemnifies the buyer in connection with any loss and damage caused as a result of the risk.
The due diligence process should be undertaken at an early stage in the acquisition or investment process, and prior to drafting the formal sale and purchase agreement. In the event that the due diligence process identifies significant issues and risks, then the prospective buyer may decide to withdraw from the acquisition at an early stage, and without incurring significant additional accountancy and legal expense.
The author, Christian Browne is a corporate solicitor and the Managing Director of Summerfield Browne Solicitors.
Summerfield Browne Solicitors have offices in London, Birmingham, Oxford, Cambridge, Northampton and Market Harborough, Leicester. Christian Browne is also a legal advisor with the Institute of Directors in London.
Summerfield Browne Solicitors
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