A pre-sale due diligence exercise is a recommendation to all sellers planning to sell their company or business in the short to medium term. In this article, associate Marc Shevlin explains why identifying issues early gives sellers the chance to remedy or mitigate them, or to raise them with the buyer.
Anticipating the buyer’s legal requirements has many advantages. It helps a seller control the timing of the work necessary to collate information so as to minimise the disruption to management’s day job of running the business. It may reveal matters which should be dealt with in the non-binding “heads of terms” which records the structure of the deal before the formal legal process begins. This can make a big difference as problems which emerge after the deal is struck may not be accepted by the buyer without a significant reduction in price.
Even if no buyer is found, a seller will often find that the exercise will improve the accessibility of key records going forward or reveal issues to be addressed which had previously been overlooked. In some ways, this exercise can be compared to a medical check-up with the result of spotting legal risks early.
Ensuring good value: a customised approach
How much due diligence represents good value very much depends on the particular circumstances. The approach should be customised and subject to a solid budget to control cost. In many cases it will be better value for the company’s own employees to carry out the bulk of the work with the lawyer’s guidance.
The areas covered will be those which would be expected to be raised by an experienced specialist solicitor acting for the buyer. This varies depending on where the buyer sees key value in the acquisition. Essentially it is about ensuring that the assets are what they seem and that the liabilities are as stated. The areas which are common to most businesses include: the shares are actually owned by the sellers, the obligations owed to employees, ongoing disputes, tax matters or accounting irregularities, and the status of intellectual property.
Some of the tasks will be routine information but likely to save time and expenses later. Many quite large companies don’t have detailed information such as group structures, banking documentation or long-term contracts readily to hand. Failures of routine filings at Companies House can be an easy trap to fall into but may have a significant impact.
A buyer’s lawyer can be expected to request lists of employees and their contracts along with organisation charts showing the employee structure of the business. A common way of approaching this is to create a spreadsheet including details such as salary, notice periods of key employees, restrictive covenants, confidential information obligations and ownership of intellectual property rights created during employment.
What will the buyer want to see?
This will depend on the kind of business being purchased.
So far as key commercial contracts are concerned; are they fully documented and up to date? How may they be terminated? Do they have unusual and expensive obligations?
For disputes, a buyer’s lawyer will first and foremost want to know if there are any. If none exist, this is a straightforward part of due diligence. However, if there are any which do exist, more details will need to be provided including the likely quantum, the parties involved and the current stage of proceedings (if commenced).
In relation to Real Estate, for non-listed companies, a buyer may be expected to check titles in the same way as a purchaser of the property itself would do. Time can be saved by having the usual information and documents to hand. This will often tie in with the position of secured borrowings which may be important to a purchaser with plans to gear the company more highly.
If intellectual property is a key part of the business, then a buyer will be keen to check very carefully that it is secure with appropriate registrations and documents. Gathering that information from trade mark and patent agents can take time and will be essential to aid a smooth sale.
As part of the sale process, a large and often time-consuming matter will be providing key information about the target company to the buyer and its advisers. Collating all key information and documents into a virtual data room is a key element to an efficient sale process. Doing this well, and ensuring that the data room and its contents are organised and easily accessible will minimise time delays or repeated enquiries from the buyer’s advisers.
Conclusion
Although sellers often do not realise it, they have a significant interest in ensuring the buyer’s due diligence is very thorough and complete. This is because usually individual shareholders will be obliged to give “warranties and indemnities” which even after skilful negotiation can be in broad terms. Therefore, if a few months after the sale completes a large liability emerges which was not disclosed against, the individual shareholders may well be personally liable. This can be a worry hanging over sellers and if a claim is made, it may not be resolved quickly. Matters which a prospective buyer identifies as a real risk may even lead to an indemnity being requested which will compensate the buyer on a £ for £ basis for losses incurred in relation to that known issue.
By being prepared in respect of the points mentioned above, the overall process will run much more efficiently and will greatly reduce the risk of a prospective buyer abandoning the deal or, renegotiating the price. This can be even more beneficial if there are strict deadlines to adhere to.
Marc Shevlin is an associate in the corporate and commercial team. He advises a wide range of clients ranging from SMEs and start-ups to larger businesses on all aspects of corporate law.
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