Due diligence in corporate transactions series: understanding the foundations
Whether buying or selling a business, due diligence is one of the most important stages of the transaction process. It enables the parties to identify and assess risks, verify important information and address potential issues as part of the wider transaction.
In the UK there are two principal methods of acquiring a business:
- an asset purchase: where the buyer acquires selected assets, rights and, in some cases, liabilities of the business
In an asset purchase, the buyer has greater flexibility to determine which parts of the business it wishes to acquire. Due diligence is therefore important in establishing precisely what is being transferred and whether the seller has the right and ability to transfer those assets. The findings can help determine the scope of the assets and liabilities included in the transaction and identify any consents or other steps required before completion.
- a share purchase: where the buyer acquires the shares in the target company
In a share purchase, the target business continues to own its assets, remains party to its contracts, continues to employ its staff and retains its historic and ongoing liabilities. The buyer must therefore understand not only the business and assets it is acquiring, but also any legal, commercial or regulatory risks which may remain within the company following completion. Legal due diligence is the process through which the buyer and its advisers investigate the target business, verify the information provided by the seller and identify matters that could affect the proposed acquisition. Its purpose is not simply to collect documents or produce a long list of potential issues, but to focus attention on matters which could affect value, deal structure, contractual protection or the decision to proceed.
In the first of our Due diligence in corporate transactions series, we provide a guide to the foundations of legal due diligence.
Due diligence for the buyer
For a buyer, due diligence provides an opportunity to understand the target business and the risks that will be acquired if the transaction were to complete at that point in time.
Depending on the nature of the target business and the proposed transaction, due diligence can help the buyer:
- confirm that the sellers own the shares being sold and are entitled to transfer them;
- verify information provided by the seller;
- identify legal and commercial risks;
- test the assumptions on which the valuation and purchase price are based;
- determine what warranties, indemnities and other contractual protections should be included in the transaction documents; and
- plan for the integration and operation of the business following completion.
Due diligence does not necessarily eliminate risk. Instead, it enables the buyer to make an informed decision about whether a risk should be remedied, allocated to the seller, reflected in the purchase price or accepted as part of the commercial bargain.
Due diligence for the seller
Due diligence is not solely for the benefit of the buyer. For a seller, preparing for and responding to due diligence can help protect the value of the business and support a more efficient transaction.
A well-prepared seller can use the process to identify gaps in its corporate records, contracts or compliance arrangements before those issues are raised by the buyer. Where appropriate, those matters can then be rectified or explained at an early stage, reducing the risk of unexpected delays or last-minute attempts to renegotiate the commercial terms.
The process also assists the seller with the preparation of the disclosure letter. The information collected for the data room and the responses given to the buyer’s enquiries will often form the basis of the disclosures made against the warranties in the share purchase agreement.
A proactive pre-sale review can therefore help the seller:
- protect the agreed valuation of the business;
- identify and address potential issues before approaching buyers;
- organise the information likely to be requested;
- reduce disruption to management during the transaction;
- accelerate the transaction timetable; and
- prepare for the warranty and disclosure process.
In the second part of our Due diligence in corporate transactions series, we provide a guide to a typical process and identify key business areas which frequently come under legal review during a transaction.
How Hamlins can help
Our Corporate team acts for entrepreneurs, SMEs and larger organisations, providing corporate, commercial advice and business expertise, both in the UK and internationally.
We have extensive experience supporting clients with the sale of their business or the purchase of a target, including managing the due diligence process which accompanies these transactions. We work with clients to identify the issues that matter, assess their commercial significance and ensure that they are appropriately addressed in the transaction structure and documentation. If you would like to explore an opportunity in respect of purchasing or selling a business, please get in touch to find out more.