In any corporate transaction there has to be a good title to its assets and has no outstanding claims that could affect the business’s operations. To give this comfort, the buyer will undertake due diligence…
A solicitor will help streamline the due diligence process, which can help in hitting a completion date. If acting for the sellers or the target, a solicitor will respond to the due diligence enquiries. Where acting for the buyer, a due diligence report will follow, which will flag up any areas of concern. A purchase price can be subject to the results of any due diligence.
Key Aspects of Due Diligence
Due diligence is broadly split into financial due diligence, i.e. the target’s outstanding liabilities and liquid assets, and legal due diligence, i.e. employees and intellectual property.
With regards to legal due diligence, the enquiries to raise will depend on the target’s market. However, broadly speaking, the following seven enquiries should always be raised:
1. Contracts
If the target offers a service, then are there watertight terms and conditions for the target’s engagement to provide services? What are the risks of these terms and is there any exposure? If the target sells goods/products, then does the target have standard form sale contracts? If so, are these contracts compliant with the implied statutory provisions, and/or the regulations of the EU?
2. Employment
Does the target have employees? If so, have they all been provided with written terms of their employment? If the buyer is acquiring assets, then TUPE will likely apply. In the last twelve months, have there been any dismissals/redundancies, and if so, how have these been dealt with? Another key area is employment policies, and whether they are in place, e.g. bribery policy, and grievance procedures.
3. Disputes
Is the target subject to any ongoing dispute with a supplier, client, or customer? If so, will completion be conditional on the resolution of any dispute subject to the satisfaction of the buyer? The seller should take steps to resolve disputes out of court, as litigated matters in the courts can become protracted.
4. Intellectual property
From a seller’s perspective, it always pays to have the business’s intellectual property rights adequately protected. If the target has a revenue stream through a licensing model, then a review of the licence agreement can help address any areas of concern.
5. Assets
How is the purchase price arrived at? If the seller owns a large portfolio of fixed illiquid assets, then the seller will want the business valued using EBITDA. That is to ensure that the value is not diminished by amortisation and depreciation. A target with consistent cash flow and a high level of goodwill will likely wish for a valuation based on EBITDA. A buyer should look to the terms of any property lease, which may have change of control provisions that can be triggered on a business sale.
6. Compliance
Many tech-driven businesses rely on software usage and large quantities of data. How is that data protected? Is the business registered with the Information Commissioner’s Office (ICO)? Does the target ensure that the business only transfers or processes data to recognised entities having appropriate protection in place? Transfers of data outside the EEA bring special considerations.
7. Ownership
Bespoke articles and/or shareholders’ agreement will usually contain provisions relating to share transfers. Do the majority shareholders have the right to “drag” the minority into a sale? Likewise, do the minority shareholders have the right for their shares to be bought out by the buyer? This will depend on how the purchase is structured.
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