Mergers and acquisitions (M&A) are a key route for businesses to grow, restructure, or facilitate an exit for the present owners of the business. According to B P Collins’ corporate and commercial practice, most M&A deals follow a well-established sequence of steps, with one of the most critical being due diligence.
In M&A, due diligence is the stage where the buyer and the buyer’s advisers have the opportunity to carry out a thorough investigation of the target business. The buyer’s objective is to gain a clearer understanding of the business being acquired, identify any potential risks, and assess whether the deal terms remain appropriate.
Key phrases of due diligence
The due diligence process usually starts after the buyer and seller agree on the preliminary terms of the transaction, which are typically documented in a Heads of Terms (HoTs) agreement – Read our article on Heads of Terms.
At the due diligence stage, the seller grants the buyer and their advisers access to essential documentation, usually via a virtual data room (VDR). Using a VDR allows for an efficient and secure review of all relevant materials.
During the due diligence stage, the seller will provide access to its sensitive business information so if the parties have not already entered into a non-disclosure agreement (which is sometimes incorporated in the HoTs), the seller will want to ensure that a satisfactory non-disclosure agreement has been entered into before providing access to its sensitive business documents. Particularly sensitive data can be further protected by restricting access to certain individuals in what is called a ‘clean room’. Also sensitive data may not be released until much later in the process.
Professional advisers such as legal, financial, and technical experts are often instructed to review the documents provided by the seller and identify any red flags. The buyer’s lawyer may begin drafting the Purchase Agreement, the core contract outlining the terms of the sale, whilst due diligence is taking place, but this is not always the case.
What should buyers be reviewing?
The scope of the due diligence exercise is tailored to the specific nature of each business. However, there are key areas that are typically examined:
Financial and tax matters (these are often reviewed by specialist accounting/tax advisers)
- Accounts: Review the target company’s financial statements to understand revenue streams, profit margins, and overall financial health.
- Existing debt and liabilities: Identify current debts, repayment schedules, and any security arrangements that may need to be released as part of the M&A transaction.
- Tax compliance: Confirm that tax filings are up to date and investigate any potential disputes or liabilities, including corporation tax, VAT, or employment taxes.
Legal structure and ownership
- Corporate Structure: Confirm the ownership of shares, group structure, and any joint ventures or subsidiaries that could complicate governance.
Assets and real estate
- Property ownership or leases: Clarify how key physical assets are held, whether owned or leased, and on what terms the real estate is held.
- Asset registers: Ensure all essential assets are accurately recorded and properly maintained.
Commercial Relationships
- Key contracts and agreements: Review key customer, supplier, and leasing contracts, paying particular attention to clauses that could be triggered by the M&A transaction.
- Pending litigation: Investigate any ongoing or threatened disputes, regulatory investigations, or prior claims.
- Third-party rights: Examine whether any agreements grant sublicensing or subcontracting rights to third parties, which could dilute control or profitability.
Intellectual Property and IT Systems
- IP ownership: Confirm ownership of all intellectual property including trademarks, patents, software, and domain names.
- Licensing arrangements: Review licensing arrangements and check the applicable terms, for example, whether other parties are entitled to royalties.
- Cybersecurity and data protection: Assess compliance with data protection laws (including UK GDPR) and the overall cybersecurity framework.
Employment and HR
- Contracts and benefits: Review employment contracts and any bonus, pension, or equity schemes.
- Disputes and redundancy risks: Identify any employee claims, grievances, or restructuring issues.
- Key person risk: Assess reliance on specific individuals whose departure could impact the business. Retention strategies should also be reviewed.
Common challenges
Due diligence rarely proceeds without challenges. Missing or incomplete documentation can create delays, and it’s common for the buyer’s advisers to make follow-up requests, which can extend the process from weeks to months, depending on how efficiently the sale-side can provide the requested information and how detailed the buy-side due diligence exercise will be.
Findings that emerge during due diligence do not necessarily mean the end of the deal. Many issues can be resolved through revised terms, such as adjustments to the purchase price or enhanced buyer protection in the SPA. However, in more serious cases, the buyer may decide to walk away.
Final thoughts
Due diligence is not just a legal formality, it’s a vital stage that gives the buyer the chance to understand in depth the target business’s affairs (and they will have access to information that they have not seen in earlier negotiation stages) so that they have the confidence to proceed. Having experienced legal advisers can make the process faster and more efficient.
If you are considering buying or selling a business and would like advice or support with any aspect of the due diligence process, our corporate and commercial team at B P Collins is here to help. Please email enquiries@bpcollins.co.uk or call 01753 889995 to get in touch. Our experienced lawyers are here to guide you through each stage of the transaction with confidence.
