What is due diligence?
The Oxford Dictionary attributes the term ‘due diligence’ to the field of law, and defines it as “reasonable steps taken by a person to avoid committing a tort or offence”. In everyday terms, and when applied to the context of buying a company, due diligence is the process of gathering as much information about the company as possible before a contract is signed and any fee is handed over.
A prospective buyer may wish to learn about all aspects of the company before completing a transaction, in order to evaluate its value and potential. Gathering the information prior to a sale also allows the buyer and the current owner of the target company to negotiate the deal fairly, based on the information available.
Why is it necessary?
Due diligence is a fundamental factor of any sale, whether it be buying a car, a house, or a business. Without due diligence (in other words, without carrying out extensive research before buying a product), the buyer may be misled, and they may sign a contract without fully understanding the product (in this case, the target company).
Due diligence is especially necessary in private company acquisitions, and in cases where the target company shares little information publicly.
What to consider?
Arguably the most important aspect of due diligence is the topic of finance. The prospective buyer will most likely be keen to learn about all things financial within the target company, and it is within their rights to gain such information before they complete the transaction. They will mainly be interested in seeing the company’s financial statements and any projections for its future performance.
The buyer will also be interested in learning about the target company’s clients, the main questions being: who are they and what revenues are generated from them? Are the clients satisfied with the service? Also, importantly, is it likely that the clients will continue to provide their business if the company falls under new ownership?
Information regarding assets, intellectual property and technology may be requested by the potential buyer, and this may include viewing any legal information surrounding these topics. The buyer may also request to see any insurance documents that the company may possess.
If the buyer is a larger organisation, or is an individual acting on behalf of one, they may wish to assess how well the target company will fit in strategically within the wider, acquirer company. The buyer may reach a conclusion regarding this topic at the end of the due diligence process, once they have conducted an overview of the target company itself.
However, before the buyer is even able to view and access any of this information, they have to sign a legally binding confidentiality agreement (or a Non-Disclosure Agreement). Once signed, this means that the buyer is agreeing to keep all of this information completely confidential.
When the due diligence process is complete, the buyer should have a good sense of the company and they will probably know whether or not they would like to complete the transaction. If they decide to go ahead, then the two parties will continue with previous negotiations as set out in the ‘Heads of Terms’ document.
Organisation and good communication between the two parties are essential aspects of this process. A combination of exceptional organisation and sound dialogue between the potential buyer and the target company should make the due diligence process run smoothly and efficiently, and in turn, this should lead to a fair and successful sale.