Due Diligence in a Business Purchase in England

English law operates under the principle of caveat emptor, meaning that the buyer takes the business as is. Accordingly, if you finalise the transaction and discover some defect in the value of the business, you will not have any recourse against the seller. The only exception is if there is a term in the purchase agreement that says otherwise. Therefore, the buyer is responsible for uncovering any hidden liabilities, risks, and defects that might impair the value of the business. The process for uncovering this is called due diligence. This article will provide an overview of a buyer’s due diligence process in a business purchase. 

Due Diligence in a Business Purchase

The due diligence process (DD) depends on how parties to a transaction wish to structure the business purchase. Generally, the buyer would prefer an asset purchase because it limits the scope of the DD to the relevant assets. On the other hand, a share purchase is riskier because you inherit the business as-is, including any hidden or undisclosed liabilities. 

Depending on the outcome of DD, the buyer will either:

• agree to acquire the company at a price agreed to under the non-binding heads of term;
• seek to renegotiate the preliminary price to a lower value because the DD uncovered something that makes the business less valuable; or
• walk away from the deal because the DD uncovered liabilities that make the deal commercially unviable. 

Scope of Due Diligence 

As a business involves different aspects, such as operational, financial, and legal elements, there are also different aspects to DD. In general, we can distinguish between:

• strategic due diligence; 
• accounting due diligence; and 
• legal due diligence. 

For more complex transactions, different advisors will carry out each aspect of DD. Respectively, these tend to be:

• management consultants and corporate finance professionals;
• accountants; and 
• lawyers. 

In practice, each of these aspects will often overlap with the others. The next section explores each in turn. 

Strategic Due Diligence

Generally, a buyer would complete the strategic element of the DD at an earlier stage in the negotiation process. Strategic DD also primarily relies on public information. In essence, the buyer wants to know:

• the market position of the target; 
• its financial position; and
• the target’s business plan. 

As the buyer, your senior management can undertake this directly. You may also wish to appoint business advisers with relevant experience. Additionally, your financial advisers may advise you on this if you are obtaining any outside finance to fund the acquisition. 

Accounting Due Diligence

Usually, the buyer will instruct its accountants to investigate the financial and accounting aspects of the company and produce a comprehensive auditor’s report. An accountant will typically require access to private and sensitive information about the target. Therefore, this DD stage typically begins after parties have drafted their heads of term (similar to a non-binding agreement in principle). 

While the scope of the report depends on the particulars of the target, in general, it will cover:

• an analysis of the target’s market, its position, customers and clients, market share, and main competitors; 
• the target’s pricing policy and any terms of trade, credit agreements, debt financing, and supplier agreements; 
• the extent of the target’s tax liabilities and ability to meet these liabilities when they come due; 
• a detailed account of the target’s profitability, balance sheet strength, and capital structure analysis; and
• information on valuable property such as land and equipment, amongst others. 

Additionally, the report will seek to identify key information that will be incorporated in the purchase agreement as warranties or indemnities by the buyer’s legal team. If this information later turns out to be untrue, this may give the buyer a cause of action against the seller. 

Legal Due Diligence

The legal aspect of DD has two main purposes, which are to identify:

• any legal conditions that must be satisfied for the purchase to be complete; and
• any legal matters that may impair the target’s value. 

The legal team will then use this information to draft the purchase agreement. In particular, they will draft warranties and indemnities clauses and conditions precedent. These are the conditions that must be fulfilled for the purchase to be complete. 

To do this, the buyer’s legal team will investigate several aspects of the company, including:

• the target’s constitutional documents, which disclose the rights and obligations of the shareholders, directors, and the company itself; 
• the directors and shareholders, as this can provide commercial and legal insight into the business; 
• any minutes and private registers to gain further insight into the administration and management of the company; 
• the company’s accounts, which are particularly relevant when drafting warranties and indemnities; 
• any debt financing arrangements along with any security granted over the business’ property, which can give rise to unexpected legal liabilities; and
• all key contracts, which can contain conditions that might arise if the buyer acquires the target and significantly impair the company’s value, amongst other considerations. 

Your lawyers would generally compile such information into a report and share this with the buyer’s senior management. 

Following Due Diligence 

Additionally, the buyer will review all the relevant reports with its advisers. The information is essential if you wish to renegotiate the purchase price or abandon the transaction altogether. If the transaction proceeds, the information contained in the reports helps draft the final purchase agreement. 

As a general legal principle, any information the seller has furnished the buyer (or its advisers) will be treated as true by inserting certain terms in the agreement. However, suppose these later turn out to be misrepresentations or otherwise untrue. In that case, the buyer usually has a right of action against the seller, typically either breach of contract or misrepresentation. 

Key Takeaways 

The buyer undertakes due diligence before the parties to the transaction agree to the final terms of the purchase agreement. The buyer will usually appoint strategic, financial and legal advisers to undertake independent investigations into the target business. These advisers will examine all aspects of the business to determine whether to renegotiate the sale price or abandon the transaction. 

If a buyer does not conduct a thorough due diligence process, any liabilities uncovered after the fact will be the buyer’s fault. On the other hand, if the buyer undertakes a thorough DD and the seller does not properly disclose the right information, the buyer may be entitled to make a claim against the seller. 

If you need help with a business transaction, our experienced business sale and purchase lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

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