Key Stages in the Business Sale Process – Stage 5 – Due Diligence (Part 1)

An article by Peter Watson, Prism Corporate Broking

Imagine someone coming into your home, reading all the invitations on the notice board, having a look in the rubbish bin and going through the paperwork on your desk. Intrusive?  You bet. Welcome to Due Diligence (DD).

Due Diligence is the process that is undertaken to establish that what you think you are buying is indeed what you are about to buy. Issues that are discovered might lead the buyer to walk away from the deal, or re-negotiate the deal or simply to manage the increased risk by changing the structure of the deal.

Due Diligence typically takes three forms:

  • Legal Due Diligence
  • Financial Due Diligence
  • Commercial Due Diligence

There is inevitably some cross-over between the three, and don’t be surprised to be asked for the same information, and even to answer the same questions by 2 or 3 different people!

Legal Due Diligence is almost always carried out, though the scope may change. It seeks to establish the ownership of assets (including shares), the nature and extent of any legal agreements (operating leases etc) and most importantly whether there are any potential problems/liabilities concerning the staff. The questions normally run to many pages.

Financial Due Diligence involves analysis of accounts and forecast, working capital requirements and taxation liabilities. It will normally involve an external firm of accountants, and is likely to be a requirement if any form of bank funding is involved.

Commercial Due Diligence looks at matters not specifically covered by the Legal and Financial DD.  This might (and normally does) involve the review of customer and supplier relationships, the market potential, manufacturing processes etc. It is an equally important element yet often receives less attention.

Due Diligence varies in its nature and scope but experienced acquirers such as Venture Capitalists have well established processes, which are rigorous and rarely shortcut. As a vendor it often seems like overkill, yet for the acquirer can prevent a costly mistake.

In Part 2 we will look at how a vendor can help facilitate the process, and what you should expect.