The importance of due diligence in the acquisition of a business – contracts and commercial law

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Due diligence is an integral step in the acquisition of any business, be it the purchase of assets or the purchase of shares. When done properly, due diligence helps to mitigate various business, financial and legal risks that a buyer might otherwise be exposed to when acquiring a business. Due diligence is the process undertaken by a buyer of a business to conduct a risk and compliance assessment to ensure that the target business is, among other things, profitable, in compliance with its legal, including contractual, tax and other obligations, and is operating with appropriate requirements . licenses and approvals.

The due diligence process can be extensive and robust depending on the nature, age and size of the business. It includes reviewing, investigating and obtaining appropriate professional advice on various aspects of the business and verifying the information provided and representations made by the seller.

When should due diligence be done?

While it may be preferable to initiate due diligence prior to entering into a binding contract, the seller may be reluctant to share sensitive business information prior to an agreement between the parties. It is therefore common practice for the parties to enter into a separate due diligence deed with the necessary confidentiality provisions, or the purchase contract is drafted so that due diligence is a condition precedent to the sale. This will give the buyer the right to terminate the contract if the result of the due diligence is unsatisfactory.

Types of due diligence

The types of due diligence will vary depending on the nature of the business being acquired. In general, due diligence should be carried out in the following areas:

  1. Commercial and operational

    Commercial due diligence involves an assessment of a business’s business position, including market, valuation, performance, feasibility, profitability and growth potential.

    Operational due diligence considers operational aspects of the business such as personnel, supply chain, logistics, quality, systems, technology and efficiency.

    It is sensible to engage relevant experts to help carry out business and operational due diligence on a business and appointing a subject matter expert can be essential in some industries.

  1. Finance

    It is important to obtain financial and tax advice in connection with any business acquisition. An accountant or financial advisor should be hired as early as possible during the due diligence period.

    This process involves reviewing the assets and financial records of the business to ensure that it is financially sound and that the purchase price matches the financial situation of the business.

    Financial due diligence details other financial obligations, such as employee claims, and checking a business’s tax returns and business statements to ensure compliance with its legal obligations.

  1. Legal

    Legal due diligence includes obtaining and examining information, without limitation, regarding:

    1. corporate structure of the enterprise;

    2. corporate governance mechanisms;

    3. any applicable licences, permits or approvals;

    4. insurance contracts and insurance claims;

    5. any legal proceedings to which the business is a party;

    6. any alleged legal proceedings against the business or proceedings to be brought by the business;

    7. breach of any agreements to which the Company is a party;

    8. any claims, debts, indemnity or indemnification orders brought against the business or made by the business against another party; and

    9. intellectual property rights (including copyright and trademarks).

    A business would enter into various legal agreements such as lease agreement, franchise agreement, service agreements, supply agreements, employment agreements and other such agreements. Legal due diligence includes reviewing all relevant agreements to:

    1. understand the legal rights and obligations arising from these agreements;

    2. ensure that there is no breach or alleged breach of such agreements; and

    3. determine whether such agreements are transferable and, if so, the requirements for the transfer or assignment of such agreements.

    It is wise for a buyer to hire an attorney to help them with:

    1. consulting in the field of legal risks associated with business;

    2. review of the proposed sale agreement for the purchase of the business;

    3. reviewing and advising on any relevant agreements; and

    4. dealing with necessary enquiries, including ASIC and PPSR searches.

Key with you

While due diligence can be a time-consuming and expensive exercise, it is a necessary step in acquiring a business because it allows the buyer to:

  1. assess risks associated with doing business;

  2. obtain essential advice on legal, financial, commercial and operational aspects of the business; and

  3. make an informed decision before entering into an unconditional contract.

A successful due diligence can ultimately save time and money and help reduce the stress of having to bear the consequences of any undisclosed risks to the target business.

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