Buying or acquiring a business is stressful. But one of the most critical things a buyer can do is engage in a deliberate, methodological, and meaningful due diligence process before closing a prospective transaction. Due diligence is the homework that helps ensure all parties are making informed decisions, especially the buyer.
What is Due Diligence?
Due diligence is the process of verification, investigating, and auditing of a business that is the subject of a potential transaction. In the mergers and acquisitions space, due diligence is utilized to collect information about the other party, including a business’s fair market value, assets, debts, and liabilities. While the due diligence process is generally more significant for the buyers, sellers occasionally take advantage of this process.
Reasons Due Diligence Should be Performed
There are many reasons why due diligence should be conducted, including but not limited to:
- Confirming that the seller has good title to the stock or assets of the business you want to acquire.
- Examining any potential liabilities or risks.
- Verifying the value of the business.
- Identifying necessary measures to integrate the target business.
- Attaining a greater understanding of how the target business functions and operates.
- Identifying any obstacles to the transaction, such as third-party approvals, a required stockholder vote, or transfer bans.
- Establishing if any additional documents are required.
- Perhaps most importantly: Determining whether a prospective deal will help accomplish your goals and objectives.
Common Documents Encountered During the Due Diligence Process
Documents such as the certificate of incorporation, by-laws, limited liability company agreements, or stockholder agreements will help identify the following issues to consider:
- Capitalization and equity ownership;
- Consent issues;
- Transfer restrictions and preemptive rights (which can prevent one or several shareholders from unwelcomed new shareholders); and
Take note of customer and supply contracts, operating contracts, and licenses. Upon review, it is important to take note of the following:
- The parties;
- Change of control provisions;
- Termination; and
Mergers and Acquisitions Agreements
It is important to take note of the parties, purchase price adjustments, escrow funds, survival of representations and warranties, and non-compete obligations.
Ensure a comprehensive review of loan agreements, hedging agreements, guarantees, and promissory notes. It would also be important to identify any liens on the target business and/or restrictive covenants that may impact the transaction.
It is crucial to verify if the target business has any pending claims and its litigation history (including any previous payouts).
How Does the Due Diligence Process Impact the Transaction?
The findings of your due diligence review can impact your transaction in several potential ways, including, without limitation, affecting the purchase price you are willing to pay. They can also open your eyes to the realities behind a seller’s representations and warranties, alert you to unknown liabilities, and, in extreme situations, uncover a dealbreaker.
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This material is provided for informational purposes only. It is not intended to constitute legal advice, nor does it create a client-lawyer relationship between MNK Law and any recipient. Recipients should consult with counsel before taking any actions based on the information contained within this material.