For buyers, due diligence provides a layer of protection against making a poor investment. It can uncover potential deal-breakers, such as significant financial liabilities, legal issues, or operational challenges that might not be apparent at first glance.
For sellers, due diligence can streamline the sale process, build trust with potential buyers, and ultimately lead to a more favourable sale price. Addressing any issues uncovered during due diligence before going to market can enhance the business’s value and attractiveness to buyers.
What is due diligence?
Due diligence is a comprehensive information gathering exercise, involving financial due diligence and legal due diligence.
The financial due diligence reveals information about the profitability of the business, its financial performance, and tax compliance. This work is usually managed and analysed by an accountant.
The legal due diligence will uncover any legal and commercial risks involved in buying the target business, including potential liabilities, ongoing or potential litigation, compliance with regulations, and intellectual property issues.
Why due diligence is important for buyers
Typically, the buyer, with help from their team, takes charge of the due diligence process. This involves asking for and reviewing information and documents from the target business.
Buying a business means taking on everything that comes with it, including any past or present issues, whether you know about them or not. The due diligence process shines a light on any potential problems that could affect how much the business is worth to you. Depending on what you find, you might want to talk about changing the price or ask the seller to cover certain risks so you’re protected.
Sometimes, due diligence can reveal big problems that make the buyer decide to back out of the deal completely. It’s a crucial step in making sure you know exactly what you’re getting into.
Sellers: what you need to know about due diligence
For sellers, the due diligence process is mainly about protecting yourself from potential claims post-sale. If you’ve given all the relevant information to the buyer, they cannot plead ignorance after they sign a sales purchase agreement (SPA) and seek compensation if they discover a problem later down the line.
The due diligence exercise will inform other key parts of the transaction like preparing your disclosure letter and drafting the warranties. Again, these are crucial elements of the process to protect you from future claims. An experienced corporate lawyer will be able to guide you through the entire process.
Due diligence checklist when buying a business
The size and scope of the due diligence exercise will vary from one transaction to another. Here is an idea of the documents and information that are commonly included in due diligence:
- Financial information
- Management accounts
- Financial statements
- Customer information
- Who are your largest customers?
- Information about the sales pipeline
- Supplier contracts
- When will they expire?
- Are there any difficult obligations?
- Are you likely to lose any on completion of the sale?
- Property
- Which properties are owned or leased by the business
- Copies of leases, including rental costs for each property
- Employment issues
- Who are the key employees and is it business-critical if they leave on completion?
- Pension arrangements and liabilities
- Data protection
- Accreditations and safeguards for keeping data secure
- Any recent breaches?
- Litigation
- Are there any claims commenced or contemplated against the company?
- Insurance
- What insurance policies does the company have in place?
- Intellectual property
- Does the company hold any patents or trademarks to protect its IP?
How long does due diligence take when buying a business?
How long the process takes depends on the size of the target business and how co-operative both sides are.
The first step is identifying the documents you want from the seller. It can take time for the seller to collate and send the relevant documents.
For smaller transactions, the process can take a matter of weeks. For larger transactions with multiple entities, the process may take months.
Here are the key steps:
Preparation: The buyer and seller agree on the scope of the due diligence investigation.
Documentation review: The buyer examines financial, legal, and operational documents provided by the seller.
Site visits: The buyer may visit the business’s premises to understand its operations better.
Interviews: Discussions with key management and staff can provide insights into the business’s operations and culture.
Analysis: The information gathered is analysed to identify any risks, liabilities, or valuation issues.
Need expert guidance on due diligence?
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