The Due Diligence process
13 February 2024 by William Hagerty
Mergers and Acquisitions (M&A) are complex transactions, with often high stakes and high value. Due to this, advising and acting on M&A requires a careful approach in order to best mitigate risks and facilitate decision making based on evidence and fact.
A common way to ensure responsible investment in Companies is to undertake a Due Diligence exercise to assess the target companies legal, financial, tax and operational status.
It consists of the Seller being provided with a ‘Due Diligence Questionnaire’ which sets out a plethora of questions about the background of the target Company. The Seller then answers the questions, and submits evidence to strengthen and prove each answer. This can require an extensive search of documents internally within the Company as well as a logistical nightmare of processing and ensuring these are managed in an organised fashion for the Buyer to inspect.
Understanding the role of the process
Due Diligence is a rigorous process that transcends mere formalities in an M&A transaction. It aims to unearth and uncover any potential pitfalls that may exist within a Company. Some key area which Due Diligence hopes to expose are:
- Hidden Liabilities: Things such as undisclosed litigation, legal claims or intellectual property disputes can mean that post-completion, these risks materialise and buyer is left footing the bill. It can also mean that the Target Company suffers reputational damage, degrading the value of the Target Company after the Buyer has paid a premium for it.
- Contractual obligations: Recognising and scrutinising contracts that the Target Company has in place (be that with suppliers or customers) means that the Buyer is aware of ongoing financial contributions, as well as the state of play in terms of any potential liabilities. From a commercial perspective, it also means that they can negotiate more effectively if they understand what the current situation is.
- Employees: Ensuring the compliance with employment laws is a way of gaining insight into any potential employment disputes. Alongside that, an extensive investigation of the employee collective is important, as they are owed legal obligations under the Transfer of Undertakings (Protection of Employment) Regulations (otherwise known as TUPE). From a practical standpoint, it is important to investigate pension enrolment, as that will become the Buyers responsibility from completion.
- Regulatory Compliance: Investigating the Company and its compliance with certain laws and regulations (such as the varied amendments and regulations that came into effect during the Covid-19 pandemic) can ensure that the Target Company is not acting illegally, which could mean sanctions or penalties down the line. If this is not uncovered prior to completion, the Buyer will have to incur further post completion costs.
The process from a practical standpoint
Whilst it may seem that the reason behind the Due Diligence process is one aimed to uncover the ‘skeletons in the closet’ and flush these out, it also poses a commercial advantage to undertake:
- Corporate Structure and Governance: By reviewing and investigating Board Composition, the Constitution and Articles of Association of the Company and any Shareholders agreements can help the Buyer understand how best to proceed upon completion, as well as mitigate any governance-related headaches.
- Integration Challenges: by scrutinising and reviewing the target Company from the inside out makes the transition to ownership easier on completion. Without a full understanding of the operational intricacies can lead: inefficient running of the company, employee disgruntlement and erode shareholder value. All of these can lead to long term financial issues.
- Overvaluation: By truly understand the Company, what it does and how it does it as well as who helps it do what it does and with what costs means that a fair price can be reached. This is one of the ultimate goals for the Buyer to ensure they are not overpaying for what they are getting.
Whilst it may seem like the Due Diligence exercise is one sided- with one side trying to uncover ‘the smoking gun’ it is a corporative process, with both sides trying to reach an agreeable medium. It is not simply a tick box exercise, but requires active investigation and review of documentation.
Starting this process may seem daunting, but our Corporate team at Fisher Jones Greenwood is equipped to guide you through every step. Please give our expert team a call on 01206 5435700 or email us at [email protected].