What steps should be taken before buying or investing?
In the context of a business acquisition or investment, it is the purchaser/investor (as applicable), rather than the seller/investee, who must take proactive steps to examine the target in question. The principle of “buyer beware” means that, by default, the buyer/investor accepts the risk of unforeseen obligations, defects and/or other issues that may exist within the target. As such, due diligence is a pivotal way in which the buyer/investor can mitigate those associated potential risks.
The process is designed to identify and assess a business’ legal, financial, tax and commercial position to inform the structure and terms of the transaction before committing to the purchase or investment. This may, for example, help the buyer/investor conclude whether the deal is economically viable.
Key areas of Due Diligence
The scope of diligence will depend on the nature and size of the business and structure of the deal (e.g., share vs asset purchase). However, some core areas are typically always covered:
- Corporate structure and constitution:- reviewing the company’s corporate documents, group structure, share capital and shareholder rights to ensure good title to shares or assets and verify authority for the transaction.
- Contracts and Commercial Agreements:- examining key customer and supplier contracts of the business, its own terms of service, and any change of control provisions that may be triggered by completion of the transaction, which might, for example, allow key customers to terminate their contracts.
- Employment and Pensions:- analysing the target’s employment contracts, senior hires and terminations, policies, potential tribunal claims, and pension obligations.
- Intellectual Property and IT:- assessing ownership and licensing of all intellectual property, trade marks, domain names, and software that are critical to the continuation of the business.
- Real Estate:- reviewing the ownership or occupation of any property at which the target operates. This may include investigation of related lease terms, rights of use, and any material liabilities such as rent arrears or dilapidations.
- Disputes and Compliance:- investigating any ongoing or threatened litigation, regulatory compliance (e.g., GDPR, health and safety), and anti-bribery policies that the target may or may not have in place.
- Finance and Security:- confirming and reviewing the existence of loans, security granted (such as debentures or charges), and other associated banking arrangements that are in place at the target.
- Insurance:- establishing the level of insurance cover the target in question has in place, and whether this needs to be improved upon before commitment is made to the purchase/investment.
Managing Risks in the Transaction Documents
Findings from due diligence feed directly into how the transaction documents are drafted. Once issues are uncovered, they are mitigated by way of negotiation, in relation to an acquisition, in the purchase agreement between the advisers for the seller and the buyer, or, in the case of an investment, in the subscription agreement between the investor and the target (and potentially its Founders). Common mechanisms to address identified risks include:
- Warranties:- the seller/target (and potentially its founders) give factual assurances about the business, such as ownership of shares, financial matters, debts, and regulatory compliance. These warranties are often shaped by what the buyer/investor learns during due diligence, and any breach may entitle the buyer/investor to claim damages.
- Indemnities:- if specific liabilities are uncovered during the buyer/investor’s due diligence, it may request targeted indemnities for any resulting losses.
- Conditions Precedent:- completion may be conditional on resolving certain issues that are uncovered, such as obtaining third-party consents or regulatory clearances that may have otherwise not have been identified in the absence of due diligence.
The role of your solicitor in Due Diligence
Effective legal due diligence not only protects the buyer/investor’s position but also promotes efficiency and clarity in the transaction and, as lawyers, we play a central role in guiding clients through this process. This may involve:
- Preparing tailored due diligence request lists.
- Reviewing disclosures and identifying legal risks, summarising the foregoing in a due diligence report, in which headline issues are flagged.
- Liaising with other advisers (e.g., tax, financial) to ensure a coordinated approach.
- Drafting and negotiating robust contractual protections in the purchase/investment documents.
The level of support we provide can of course be tailored to a client’s specific need. Our input may, for example, be limited to specific headline topics, or, conversely, be a “belts and braces” approach – this is dealt with on a case-by-case basis and is subject to a buyer/investor’s approach to risk.
We also are adept to advising sellers on the receiving end of the various workstreams identified in this article. This includes responding to due diligence requests, drafting disclosure documentation to limit risk, and the negotiation of purchase documents from a “seller-friendly” perspective.
How to Get in Contact
We specialise in corporate transactions, acquisitions and investments. Should you require further assistance in this regard, please contact Joe Moulding at joe.moulding@ilaw.co.uk or call +44 (0)203 987 0222.
