The Basics of Due Dilligence

Imagine you are about to invest in a company or purchase shares. These are both transactions involving large sums of money, so what you really want is to know what you are investing in. This is where some research is essential and in commercial law this is called ‘Due Diligence’.

‘Due Diligence’ is the collective term for the analysis of a business when considering an investment. The process normally occurs alongside negotiations of a purchase agreement, organised by a negotiating team, and helps negotiations as the buyer can decide on a price he/she wants to pay. It also gives the buyer a stronger sense of comfort and allows for a more accurate assessment in order to consider where to move the company on, covering areas such as ‘advantages v disadvantages’ and ‘strong success factors’. As well as this, the buyer can discover how much protection the company needs before setting up a contract. So here is a breakdown of the whole process.

Firstly, a focus is identified for the due diligence, meaning that time is not wasted in analysing the wrong area of the business. Direction and efficiency are vital in good due diligence. This focus will differ with the various types of companies. For instance, if a food company is being analysed, the focus would be on the sales success of their main foodstuffs.

Then, an assessment of three areas of the target company takes place- financial, legal and commercial. These are carried out by financial and legal advisers to the buyer, so that the buyer can fully assess the company’s advantages and disadvantages. The financial assessment leads the way, bringing to the foreground any risks or acquisitions the company may have. This is discovered through several meetings with the company’s management team as well as looking through their accounts. The legal and commercial assessments happen at the same time, but normally take longer due to the level of information required. A questionnaire is written for the company by the buyer’s solicitors on several matters, such a patent-protection and tax position, and completed by the seller, who returns the questionnaire with all the necessary documentation.

When this has been done, the accountants and solicitors analyse all the information as well as assessing any other outstanding areas to the company if relevant (e.g. environmental factors). This means that the probability of any information being missed is reduced and firm advice can be given to the buyer.

Finally, the buyer makes a decision on whether to invest in the company or not, based on the information found through ‘Due Diligence’. If the buyer does invest, the negotiation team draft a share purchase agreement before the buyer’s accountants and solicitors help to draw up warranties covering areas highlighted in the due diligence. If the buyer does not invest, due diligence has been successful in bringing up a flaw in the company to the buyer.

For further information on Buying and Selling a Business, please contact Izaz Ali on izaz.ali@lawdit.co.uk.

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