In any merger and acquisition, due diligence is the research that a potential buyer conducts to assess the viability of a purchase of a business. It is in a buyer’s interest to carry out due diligence on a target business. It is critical to engage a lawyer experienced in a good number of M&A transactions to oversee these investigations.
Failure to identify weaknesses in the business or financial records disclosed by the seller then becomes a legal liability the buyer inherits when he acquires the target. Examples of unpleasant surprises post-acquisition include discovering that the business acquired is bound by onerous contracts, or that key employees crucial to the business’ success have left or are leaving. After the purchase, it becomes too late to change your mind.
Typically, thorough due diligence starts with compliance and good standing. It is crucial that the business is in good standing with the law and the authorities. Minimally, the buyer must be aware if there are any ongoing legal proceedings against the business.
Next, financial due diligence will allow the buyer to better understand the financial position of the business, enabling him to assess the right price to pay for it. There are many aspects to this, but a key aspect is the uncovering of unsettled tax liabilities that the buyer would potentially have to bear.
An audit of physical assets ensures they are in good condition and are still in the company’s possession. The buyer should also check that intellectual property rights are properly registered, in whose names are those rights registered with, and that all intellectual property, whether registered or not, would be transferred to him upon completion of the sale.
The buyer should ensure that key employees remain with the company and that the business possesses all the necessary licenses and permits required for operation. Depending on the nature of the industry in which the business operates, approvals from relevant authorities might need to be sought for the purchase. The buyer should review all the business’ contracts to ascertain its rights and obligations, and also have a good understanding of the existing major customers of the business to ensure that these relationships continue after the purchase.
Due diligence may uncover troubling aspects of the target business. Warranties and other terms may be inserted to protect the buyer from losses suffered upon taking over the business. A typical sale and purchase agreement would contain warranties which serve as contractual assurances or promises. For example, it may be provided in the contract that the seller shall indemnify the buyer for any unsettled tax liabilities. In the event of a breach of a warranty, the buyer may claim from the seller any resultant losses flowing from the breach. Due diligence and warranty clauses work hand in hand and complement each other.
Yuen Law brings to the table many years of multimillion-dollar mergers and acquisitions experiences for clients ranging from MNCs to SMEs and start-ups. For assistance on due diligence for purchasing businesses, do contact us to make an appointment.