Due Diligence When Buying a Business

“Due diligence” is a phrase used to describe a process of business investigations. A purchaser will often insert a due diligence clause as a condition to be satisfied in an agreement to purchase a business or shares in a company which operates that business.

Why Do We Have Due Diligence?

The main objective of due diligence is to extract information about the important areas of the business to be purchased. Through the process due diligence provides the purchaser with greater certainty as to the likely future performance and earnings of the target business.

Engaging the appropriate experts (i.e. lawyers, accountants, financiers and others) an investigation is undertaken into the contracts, financial statements, supply arrangements and other information related to that business.

What Will You Find?

Due diligence can identify a purchaser’s exposure to third parties in the event of non-compliance by the vendor under various regulations and legislation affecting the business. It can identify those areas of the business which are vulnerable in terms of contractual arrangements with either suppliers or customers.

Due diligence may result in:

  • the purchase price being affirmed or re-negotiated;
  • additional conditions or covenants being added to the agreement;
  • better allocation of the purchase price, for example, minimising the value of the personal goodwill in the business and increasing the value of plant, equipment and stock in trade in order to maximise future taxation benefits.

In some cases, due diligence may result in the cancellation of the contract.

Risk Avoidance

No matter how thorough the due diligence process, risks still exist in purchasing a business, and enforceable warranties and indemnities from the vendor need to be included in the agreement for sale and purchase to protect the purchaser. However, these warranties and indemnities have to be enforced for the purchaser to receive the benefit of them.

A vendor seldom rolls over and pays up on a failed warranty. A purchaser may also find the vendor has disappeared, or spent the proceeds of the sale by the time the purchaser realises the warranties are needed.

The purchaser also has to bear the time and cost burden of that enforcement. Hence the need to obtain as much information as possible through the due diligence process before proceeding with the purchase.

What To Do

If you intend to purchase a business in the future, you should ensure that, as a minimum, your lawyer and accountant are involved in the due diligence process. Ideally, both these professional advisers should be involved as early as possible so that a clear and coordinated approach to the due diligence can be adopted.

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