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Due Diligence Investigations – Get It Right!

A due diligence investigation has become more and more relevant and important in recent years. An uncertain economic climate, small margins for error and objective planning, are just some of the factors that have increased the popularity and need for a proper due diligence investigation.

So, what is due diligence? One legal definition of due diligence will read more or less as follow:

“a comprehensive appraisal of a business undertaken by a prospective buyer, especially to establish its assets and liabilities and evaluate its commercial potential”

The purpose of a due diligence investigation from a buyers perspective will be therefore to:

  1. Identify and evaluate risks associated with a business’s financial, employment, legal, and tax position (to name a few);
  2. determine the condition of assets if, and when applicable;
  3. determine the actual value of the business;
  4. determine to what extent it will be willing to limit the liability of the seller pertaining to current agreements and the seller’s potential breach thereof;
  5. determine how the business will be integrated into the buyer’s current business operations.

From the perspective of the seller, due diligence can also be a healthy exercise as it enables the seller to supply important information to the buyer and in the process limit the extent of its warranties and representations.

Due diligence can occur anytime during the negotiation process but for obvious reasons, such as other potential offers, cost, and time, it is advisable to conduct the same before a formal offer is made. It can, however, happen that a buyer makes an offer on a business that on the eye looks promising, but makes the offer conditional to a successful due diligence investigation before the offer will become binding.

In order to determine what needs to be investigated, it might be sensible to use a typical due diligence investigation checklist, which will more or less comprise of the following:

 

1. Structure of the business
2. Employment considerations such as key – personnel, trade restrictions, employee benefits;
3. Current binding agreements;
4. Assets and liabilities;
5. Insurance cover;
6. Pending or imminent litigation;
7. Accounting records;
8. Intellectual property rights;
9. The actual value of the business and how the same will be determined.

It is however important to note that every transaction will be different and will therefore require different questions to be asked, and documentation to inspect. It is advisable to draft a proper due diligence investigation checklist before conducting the actual investigation, as to ensure that all important considerations have been taken care of.

At the finalization of the due diligence investigation, a report will be compiled to enable the buyer to make an informed decision on its offer and also to serve as evidence of the disclosures made by the seller.

The report also serves as a valid guideline to the drafters and advisors of the buyer pertaining to the acquisition agreements that have to be prepared.