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What is Due Diligence?

What is Due Diligence?

It’s important!

If you are thinking of buying a business or shares in a company, you will want to examine all aspects of it before committing yourself.

A comprehensive financial and commercial appraisal

Due diligence takes different forms depending on its purpose and can usually be broken down into business, property and financial elements.

The examination of a target business or company would normally be undertaken by a buyer.

The process exists to ensure that reasonable steps are taken by a prospective buyer, or their solicitor, to establish any liabilities the buyer may face in proceeding with the acquisition and to understand as much as possible about the target business or company prior to purchase. Due diligence also assists with transparency between the parties.

Is it a legal requirement?

It is not a legal requirement to carry out a due diligence exercise but rarely it will be the case that a buyer will not be advised to do so. If a buyer is being funded by the third party, the funder may require that certain due diligence is carried out.

Karen Edwards, Associate and Solicitor in the Commercial Law Team handles company acquisitions, mergers and disposals says “Carrying out this type of investigation contributes significantly to making an informed decision, enhancing the amount and quality of information available to a decision maker. We can also apply our experience in this area and using this information from due diligence to systematically help prospective buyers to deliberate on their decision and all its costs, benefits and risks. It is an essential part of an acquisition and can prevent costly regrets.”

Business transactions and corporate finance

Due diligence is the chance for the prospective buyer to ask questions about the business/company to form a comprehensive financial and commercial appraisal. It should include:

  1. An examination of certain key questions, such as the structure of the acquisition, trading activity, customer contracts, past and present litigation, assets, liabilities, employee structure, intellectual property and IT systems etc.
  2. A reasonable investigation focusing on material future matters.
  3. An investigation of current practices of process and policies.
  4. A valuation of the target against what is being paid.

The first step is to evaluate the deal. A preliminary assessment is made of the key risks and future opportunities – is the buyer still interested after evaluating this information?

A detailed investigation follows, focusing on the areas listed above. After these major areas are checked, a thorough look is taken at all the company’s records – statutory financial statements, management accounts, budgets, internal process controls, analyses and projections / forecasts and any insurance policies.

A prospective buyer must ascertain:

  • How good is the cash flow?
  • Are there any hidden liabilities?
  • Will key employees be staying with the company?
  • Whether the leases on any of the business premises are in order and when do they expire
  • Has all company paperwork, tax registration certificates etc. been provided?

What problems should you look out for?

The most common problems that due diligence reveals are to do with employees, environmental matters, pensions and property.

Karen says, “Due diligence should be carried out as early as possible, so that any problems can be dealt with. This will not delay the sale process as it can be on-going alongside the production of the purchase agreement. It might seem like a mammoth task but we are experienced in handling this type of analysis and information. It’s all about asking the right questions and knowing the right places to look for the answers.”

Our Commercial Team are happy to discuss any issues that this raises for you and we offer a free initial meeting or chat on the phone.

If you have any questions, you only have to ask us at Frettens. Please call 01202 499255 or 01425 610100 and Karen or a member of the team will be happy to chat about your situation and your particular requirements.