I Am Selling My Business. What is the Due Diligence Process?

If you are selling your business, you will likely come across the phrase ‘due diligence’. Due diligence is the process a buyer will undertake to investigate your company’s legal and financial position before purchasing your business. While the buyer will likely conduct most of the due diligence, you should be prepared to respond to their requests for information. This article will explain the key components of the due diligence process to better prepare to complete your mergers and acquisitions (M&A) transaction.

Due Diligence

In an M&A transaction, due diligence generally refers to the process the buyer takes to investigate the target company’s: 

• assets;
• liabilities;
• profitability;
• cash flow;
• internal policies;
• corporate governance; and
• regulatory compliance.  

For large or complex transactions, it is common for the seller and buyer to each instruct a financial adviser and a lawyer to guide them through all aspects of the process. The buyer usually conducts the due diligence process by asking the right questions and requesting certain information from the target company. Nevertheless, a successful and efficient due diligence process requires smooth communication between the buyer and seller. Therefore, if you are selling your business, you should familiarise yourself with the process and anticipate as much as possible.  

Purpose of Due Diligence

Acquiring a company through an M&A transaction can be a complex, expensive, and challenging task for a buyer. Therefore, the due diligence process is a critical step in a transaction because it ensures the buyer can:

• accurately value your company; and 
• limit their future financial and legal liability if the purchase goes ahead.

Valuing the Company 

Before a buyer commits to purchasing your company, they will want the complete picture of its performance. For instance, the buyer may know that the company is an industry leader in manufacturing and selling quality women’s watches. The buyer can inspect Companies House and get a general sense of the company’s value based on publicly available information. However, this alone will not likely give the buyer the complete picture it needs to commit to acquiring the company for a substantial sum of money.

To complete the picture, the buyer must comb through important documents and assemble the right information about the company’s financial and legal position. Accordingly, the target company will likely have thousands of records the buyer may wish to inspect. However, most of the information will not be public. Nevertheless, the buyer can fully understand your company’s worth by accessing important financial and legal information. 

Limiting Liability 

Buyers generally acquire businesses as they find it. This is known as ‘caveat emptor‘, or buyer beware. That is to say, if defects make your company less valuable, the buyer will not have any recourse against you outside of the terms of the purchase agreement. 

So long as the buyer asks the right questions and you provide honest responses, the buyer will have an accurate sense of any liabilities which could impact the company’s profitability or value in the future. 

The Scope of the Due Diligence

Below is a list of important matters that most buyers will want to inspect before purchasing a company. This includes:

• your company’s accounts, including profit & loss statements and cash flows, along with who compiled the accounts; 
• your company’s governing documents, such as its articles of association;
• any material changes to your business; 
• the full extent of any debt financing your company has engaged in; 
• what security agreements are in place over your company’s assets; 
• all contracts your company is a party to; 
• the title to any land your company owns;
• information related to the operation and upkeep of all your company’s assets, such as machinery or equipment;
• if your company holds any intellectual property rights or licenses and the terms governing the licenses; 
• how you established your company’s IT systems;
• all employee policies, payments and service contracts in place; 
• any ongoing or anticipated legal disputes that your company may be involved in; 
• all the insurance policies in place; and
• the extent to which your company is complying with its regulatory obligation. 

Key Takeaways 

If you are selling your business, you should anticipate buyers’ requests for information about your company’s legal and financial position. Due diligence is vital in the mergers and acquisitions (M&A) process because it ensures that the buyer has as much information as possible to accurately value your company. As such, due diligence typically involves a buyer inspecting your company’s documents to better understand its financial and legal position. 

If you need help navigating the due diligence process for an M&A transaction, our experienced business sales 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 at 0808 196 8584 or visit our membership page.

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