When buying or selling a business, the best surprise is no surprise. Whether you are the buyer or seller, due diligence is a critical stage of every transaction. Due diligence allows buyers to get a better sense of exactly what they are buying and helps sellers accurately describe their business to buyers. Conducting a thorough investigation of the company and the other party helps to ensure that you are making a well-informed decision and negotiating fair terms.
What is Due Diligence?
Due diligence refers to the review and analysis of relevant information about a party and its business. Typically, during this process the buyer seeks to verify the seller’s assets, liabilities, operations and business relationships to identify any potential problems or liabilities before the purchase. Due diligence is valuable to the seller in confirming the fair market value of their business, and in some cases, sellers should also conduct due diligence on buyers. This is especially important when there are elements of a merger or there will be a continuing relationship after the closing of the transaction. Sellers should not be shy to evaluate a buyer’s creditworthiness, assets and reputation.
The scope of the due diligence process will vary depending on the type of business, the size and type of transaction, and the buyer’s goals in entering into the transaction (i.e., how the buyer will use the assets).
Why is Due Diligence Necessary When Buying or Selling a Business?
The goal of due diligence is to determine whether there are risks that may affect the value of the business so the parties can either negotiate terms that allocate the risk between them or walk away from the deal. It also helps the buyer understand the reputation of the business, industry, market position and culture to ensure the purchase is the right fit. Due diligence cannot eliminate all risk, but it should identify likely problems and how to mitigate them, as well as help provide realistic expectations about the success of the business.
What is the Due Diligence Process in the Purchase or Sale of a Business?
The due diligence process begins when a buyer starts evaluating a business, potentially even before the approaching a seller. If the buyer and seller enter into a term sheet or letter of intent, that agreement may define a due diligence period and outline the terms, including the buyer’s rights to access certain information. Generally, the seller will require a buyer to sign a non-disclosure agreement (NDA) before beginning due diligence. The purpose of the NDA is to protect the confidentiality of information given to the buyer and to prevent the buyer from revealing the existence or substance of any discussions.
Thereafter, the buyer’s attorney will send a due diligence questionnaire or checklist to the seller requesting various types of information, including documents related to the seller’s corporate structure, financials, contracts/legal documents, intellectual property rights and compliance with relevant laws. In addition, the buyer may wish to speak with key management, customers, tenants, vendors, etc. as permitted by the NDA. The checklist should be tailored to the business and the buyer’s goals.
It is helpful for the seller to designate a due diligence contact person to manage the process and negotiate the burden of document production if the buyer’s requests are onerous. In addition, where there are large quantities of documents, it may be useful to provide a physical or virtual data room to house all information provided. This can also make it easier to keep track of what has been produced.
Once the information has been provided, the buyer and its advisors will have a certain period of time to review and analyze the material and make an assessment. This evaluation will either result in the parties moving forward with the transaction, terminating discussions or engaging in further negotiations regarding the purchase price or contract terms. Ultimately, information gained from due diligence helps shape the final agreements between the buyer and seller.
Buying or selling a business is usually a significant endeavor. To avoid making a costly mistake, you should consult an experienced attorney to guide you through the due diligence process. A lawyer can assist in multiple ways, like relaying what information you need, assessing your risks and negotiating favorable terms if you wish to move forward with your sale or purchase.
