As a Buyer, once you have decided to acquire a business, you will want to ensure its success and specifically, the longer-term integration of the new business.
A large number of acquisitions fail to meet expected targets and some high-profile disasters have brought the issue of acquisition strategy, planning, management and post-acquisition considerations sharply into focus.
The keys to a successful acquisition can be broken down into:
- Co-operative counterparties.
- Sound Professional guidance.
- Good management of the acquisition process and, in particular, the due diligence exercise.
- Proper post-completion integration of the new business, including the management of indemnity and warranty claims.
Purpose of due diligence
Every buyer wants to be sure that the seller and (in the case of a share purchase) the target company has good title to the assets being bought and to fully understand the extent of any liabilities it will assume.
Under English law, the principle of caveat emptor, or “buyer beware”, will apply.
This puts the burden squarely on the buyer who must carry out its own investigations of assets, businesses, shares and shareholders as early on as possible, ideally, at the negotiating stage.
The main aim is to obtain sufficient information about the target’s business to enable the buyer (or other parties with an interest in the transaction) to decide whether the proposed acquisition represents a sound commercial investment.
Due diligence is effectively an audit of the target’s affairs – which includes an assessment of the legal, commercial, financial and technical. Such an audit then becomes an important bargaining tool for the buyer.
Armed with the information provided in the due diligence report which is usually prepared by the buyer’s professional advisers (including the target’s critical factors, strengths and weaknesses), the buyer is in a better position to assess the risks and rewards of the purchase and can seek to renegotiate the terms of the purchase agreement or adjust where appropriate, for example to cover off a known or anticipated risk.
Based on the same information, the buyer will inevitably seek contractual protection from the seller in the form of indemnities or warranties, which serve as a type of insurance against certain predicted or unpredictable problems arising. It should be added however, that in practice, the protection offered may be limited by what is known as “disclosure” (of any items to be brought to the buyers attention against the warranties), “limitations of liability” (reducing the sellers’ liability by agreement) and other contractual provisions.
Further, damages for breach of contract (in this case, the Share or Asset Purchase Agreement) may be difficult to quantify and to secure and a buyer may have an action against the seller in misrepresentation for any false or misleading pre-contractual statements about the target business, but such actions are often excluded by the contract.
While due diligence is not a substitute for contractual protection, it assists the buyer in knowing what it is getting into at an earlier stage.
It is an aid for the buyer to work out what contractual protection it requires from the seller and what risks it is not prepared to take on.
Think of it as the research that goes into the development of a vaccine, which will be used, if and when needed. This is as opposed to trying to treat the patient after the event when the damage has been done.
For example, on a share purchase, the buyer inherits all the historical liabilities of the target. The results of the due diligence investigation might either cast doubt on whether the buyer can get what it wants from the acquisition or make it clear that it will be too risky at any price.
Legal Due Diligence – Outcomes
A due diligence enquiry should establish the following key information about the target business:
- Title – Does the seller have good title to the shares in the target company (on a share purchase) or the assets being sold (on an asset purchase)?
- Liabilities – Are there any hidden, unstated or understated liabilities?
- Information – Detailed information on the target business so that the buyer is in a better position to:
- Make a final decision on whether to proceed with the acquisition and, if so, at what price (remember “Heads of Terms”, even where they have been extensively discussed and formally executed, are usually non-binding and should always be marked “Subject to Due Diligence”);
- Negotiate a better deal with the seller;
- Plan the post-completion integration of the target business;
- Determine any consents that may be required for the transaction. These may include: minority shareholders, option-holders, lenders, contractual “change of control”, regulatory. For example, the consent of industry regulators, tax authorities, competition authorities, shareholders, Banks, key customers or suppliers of the target. Often, where one of the main assets of the target is customer contracts, it will be imperative for the buyer to find out through due diligence whether there are any contractual prohibitions against transfer; and
- Determine whether any ancillary documents will be needed (for example, a transitional services agreement).
Properly carried out Legal Due Diligence will always strengthen the Buyer’s hand and put the buyer in a better position to identify the necessary steps to take effective control and successfully transition and integrate the target’s business.
Within Legal Due Diligence, the legal position of the entire business (and all assets and liabilities) will be scrutinised. For example, this will include questions around Property owned or used by the business, employment issues, pensions, Intellectual Property, Information Technology,
Business Due Diligence
In addition to the pure legal or contractual due diligence, a buyer may wish to engage an adviser “commercial” or “business due diligence”.
Of course, this is usually something that the buyer and their accountant or in-house FD will do as an initial step. It may even be that where there is an element of competition, the parties will know each other well and the business due diligence would include the early stage analysis which prompts the conversation.
Business due diligence looks at broader commercial issues such as the industry in which the business operates, competitors, the business’ strengths and weaknesses, overall structure, how it has fared historically, production, personnel, sales and marketing, and research and development.
Some of the results of this part of the due diligence review will be relevant to the legal investigations.
Business due diligence aims to test the assumptions already made in the buyer’s acquisition plan and to identify the management action required by the buyer to take effective control of, and reduce risk in, the business once the deal has closed.
Open source libraries, especially websites, news reports and UK Companies House records, are a helpful starting point for an initial assessment, prior to a buyer making contact with a seller.
Financial Due Diligence
Finally, the buyer will likely instruct accountants to conduct a financial analysis and then prepare a full report, on the financial aspects of the target business and how this ties in with the buyer’s business.
This financial due diligence is not the equivalent of an audit, and accountants’ reports will usually make this clear. However, financial due diligence should focus on those areas of the target’s financial affairs that are material to the buyer’s decision so that the buyer can assess the financial risks and opportunities of the deal and whether, given these risks and opportunities, the target business will fit well into the buyer’s strategy or whether, perhaps, the consideration initially offered should be adjusted. Financial due diligence may also help quantify:
- Potential synergies and cost savings.
- Possible additional profit centres
- The optimum acquisition and financing structure.
- The impact of the acquisition on the buyer’s performance metrics. When the buyer’s accounting policies are more conservative than those followed in the target business, it may be necessary to make appropriate adjustments in order to measure the true impact.
Part of the accountants’ investigation will be to review the target’s audited accounts. However, please note that it is important for the buyer’s accountants to make their own enquiries as to the state of the target business, as the buyer will not generally be able to rely on the target’s audited accounts due to rules around auditors’ negligent mis-statements, which is an in-depth issue in itself.
Sometimes sellers may instruct its accountants to prepare a report on the target which it will then make available to buyers. This helps the seller determine appropriate values for the business it wishes to sell and may limit the due diligence potential buyers wish to undertake.
If the buyer is a publicly listed company, depending on the size of the acquisition, it will need to give shareholders certain financial information about the merged group. Accountants will need to review the target’s figures in order to provide this information.
“Covert” Due Diligence – Corporate Investigations
Professionals, such as solicitors and accountants, are occasionally instructed to find out information about a specific target that a buyer is considering making an offer for, or alternatively, a seller may wish to find out information on a buyer. In each case, one party may not desire to place the other party “on notice” about the investigation.
Much of the information researched is open source, but we would urge party to use caution where lines of confidentiality and privacy are crossed.
We frequently work with world renowned experts in this field of corporate and private investigations, who are highly trained and who are often able to extract, decipher and compile information that is non-public and occasionally proprietary to a party.
Most clients in M&A situations do not require this level of secretive due diligence as the process is more collaborative.
Standard UK Due Diligence Request Lists
To assist with the due diligence process, we have provided these due diligence information request lists for use in both Share Sales and Asset Sales:
- A legal due diligence information request for use in connection with the acquisition of the entire issued share capital of a private limited company.
- A legal due diligence information request list to be used in connection with an asset or business purchase.
Due Diligence Assistance – Contact
Should you require assistance with any form of Due Diligence or information gathering – whether as part of a broader legal mandate or as a limited instruction – we would be happy to assist you in your goals.
Jonathan Abrams, Solicitor & Attorney at Law,
Head of Business Services
Tel: 020 8004 7016
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