Summary
- Due diligence is the investigation a buyer undertakes before purchasing a business, covering financial records, legal obligations and regulatory compliance.
- English law operates on the principle of caveat emptor: buyers take a business as found and have limited recourse if issues emerge after completion outside the purchase agreement’s terms.
- Sellers should prepare documentation in advance, including financial statements, tax records, key contracts and corporate governance records, to respond efficiently to buyer requests.
- This guide explains the due diligence process in UK business sales for business owners and founders preparing to sell.
- LegalVision’s business lawyers specialise in advising clients on mergers and acquisitions, including due diligence.
Tips for Businesses
Organise your financial records, tax returns and key contracts before the buyer’s due diligence process begins. Address known liabilities early and disclose them accurately in the purchase agreement. Instruct a solicitor to advise on legal due diligence and assist with warranties and indemnities before heads of terms are signed.
Due diligence is the formal investigation a buyer conducts before acquiring a business. The principle of caveat emptor applies: if defects come to light after completion, the buyer generally has no recourse against the seller unless the purchase agreement says otherwise. The process covers financial records, legal obligations, key contracts, employee arrangements and regulatory compliance. For sellers, preparation matters as much as disclosure. Solicitors and accountants typically guide both parties, particularly on complex M&A transactions. The depth of due diligence depends on deal structure, whether share purchase or asset purchase, and the size of the target business. 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;
- reputation;
- corporate governance; and
- regulatory compliance.
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.
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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.
Considering purchasing a UK business? Download this free guide for practical tips on conducting due diligence and reducing risks.
To complete the picture, the buyer must comb through important documents and assemble the correct 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.
Setting up a data room
Most M&A transactions involve a virtual data room, a secure online repository where the seller uploads key documents for the buyer and their advisers to review. Organising your data room before the buyer’s formal requests arrive can reduce delays considerably and signal to the buyer that the business is well managed.
Documents typically included are statutory books and constitutional documents (including the articles of association and shareholder registers), audited financial statements for the past three to five years, key customer and supplier contracts, employment contracts for key personnel, intellectual property registrations and licences, and any regulatory permits required to operate.
Questions to Expect
Every transaction is different, so you can never predict the exact questions and information a buyer will request. However, there are specific key issues you can always expect to be asked and should prepare for.
Unsurprisingly, a buyer or investor will want to see detailed financial information about your business. This might include details such as your balance sheet, P&L accounts, tax returns, management accounts, future financial projections, and details of all outstanding loans and credit facilities.
Other aspects of your business that you may be asked to provide include:
- team members and structure;
- operations and processes;
- growth strategy and plans;
- key clients, contracts and relationships; and
- corporate structure.
Key Takeaways
For these reasons, a thorough due diligence process ensures that the buyer knows exactly what they are acquiring when they buy your business. For instance, your company could be less valuable if the buyer acquires it and someone decides to sue it. So long as the buyer asks the right questions and you provide honest responses, the buyer will have an accurate sense of any liabilities that could impact the company’s profitability or value in the future.
If you need help understanding the due diligence process, our experienced corporate 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.
Frequently Asked Questions
What is the difference between a share purchase and an asset purchase in due diligence?
In a share purchase, the buyer acquires the company as-is, including all liabilities, making due diligence more extensive. In an asset purchase, due diligence focuses on the specific assets being transferred. Buyers generally prefer asset purchases to limit their exposure to undisclosed liabilities.
What does a buyer’s legal team examine during legal due diligence?
The buyer’s lawyers typically review constitutional documents, director and shareholder details, company minutes and registers, financial accounts, debt financing arrangements and key contracts. They compile findings into a legal due diligence report for the buyer’s senior management, which informs the warranties and indemnities in the purchase agreement.
Do I need a solicitor to carry out due diligence?
Solicitors are not legally required, but engaging one is strongly advisable. A solicitor specialising in business acquisitions can identify legal risks that may not be obvious from financial documents alone, advise on the transaction’s value, and draft the warranties and indemnities that protect the buyer after completion.
What happens after due diligence is completed?
Once due diligence is complete, the buyer reviews the findings with their advisers. Depending on results, they will either proceed at the agreed price, renegotiate downwards to reflect identified risks, or walk away from the deal entirely. The findings inform the warranties and indemnities in the final purchase agreement.
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