The importance of due diligence in acquisitions

‘Caveat emptor’ or ‘buyer beware’ is the underlying legal principle to be considered by buyers when deciding whether or not to buy a business, as it places the onus on the buyer to fully investigate the risks and liabilities before entering into a legally binding purchase agreement. The process of investigation in an acquisition is known as due diligence (DD) and is undertaken by the buyer, the buyer’s solicitor and their accountant.

A thorough DD investigation will depend largely on the specific requirements of the buyer and the transaction. DD usually covers the following areas:

Legal DD, to determine:

• details of the current share capital;
• the company’s corporate structure and records;
• the extent of insurance cover;
• which existing contracts and trading arrangements are in place and how these will be affected by the transaction;
• who are the current employees and what are the pension arrangements;
• past, present and potential litigation;
• ownership of real estate, intellectual property and assets; and
• which regulatory licences and consents are required and whether these have been obtained.

Business/commercial DD, to assess:

• the status of the business in the current market;
• marketing strategies;
• development of the business;
• key competitors of the business; and
• key customers and suppliers of the business.

Financial DD, to consider:

• financial risks and opportunities;
• recent accountants reports;
• management accounts;
• profit and loss balances;
• budget plans; and
• valuations of assets.

Tax DD, to assess:

• any potential or previous tax liabilities and compliance with HMRC regulations.

The aim of DD is to ensure that the buyer can acquire good title to the shares/assets, that they are aware of the full extent of liabilities that they may be taking on, and that they have an accurate valuation of the company and/or its assets. This will place the buyer in the best possible position to identify what contractual protection (in the form of warranties, indemnities and/or conditions) they will require from the seller. The scope of DD will depend on the size of the deal, the requirements of the buyer and the aims of the transaction.

At Harrison Clark Rickerbys, one of the first questions that we ask a buyer is: “how much DD would you like us to do?” Establishing the appropriate level at the outset allows us to facilitate an efficient and cost effective process, whilst addressing our clients’ concerns over the risks involved with the acquisition.