A prospective buyer or investor investigates and gathers all possible information about a seller company and its business/assets. The purpose is to decide whether to proceed with the transaction on initially discusses terms, establish areas of risk that need particular attention and if justified withdraw from the proposed investment, Representations s and warranties by the seller are no substitute for the due diligence process. () It is imperative that an investor understands the key drivers of business performance and the issues which could impair or enhance that performance. The due diligence process includes the gathering, analysis and interpretation of financial, commercial and legal information. It may include a review of trading patterns, financial projections, markets, products, customer base, asset management, cash flows, taxation, HR, accounting, and information systems. (KPMG Professional advice)
Conducting the legal due diligence process will vary depending on the type of business, the size of the business and the complexity of the overall organizational structure. At a minimum, the buyer should ask for copies of, or get a written explanation of, the following items:
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Basic firm information - including brief history, structure, size, lines of business, registrations, personnel turnover, and the like.
- Financial information – Audited statements and business plans.
- Compliance systems - Relevant laws, regulatory issues, and compliance requirements; including manuals, training and officers.
- Internal procedures – Company policies and guidelines, including a code of ethics.
- Principal service providers – Lawyers, accountants and consultants.
- Significant business relationships – Suppliers, vendors, customer base.
- Material contracts and agreements – Finance relationships, leases, material correspondence, employment agreements.
- Warranties and insurance coverage.
- Any pending litigations – Inquiries an investigations.
- Taxation – Income tax returns, assessments or company liabilities.
- Patents and copyrights, and other intellectual property-related documents.
This checklist may not cover everything relevant for all investors, but it should serve as a good starting point. If the seller objects to or resists providing any of the requested information, a red flag has just been waived. The investor should inquire thoroughly into the nature of the objection. There may be legitimate concerns behind some of the items requested, but having a clear understanding of what they are will allow the adviser to respond most appropriately. If the seller objects to discussing a matter of particular sensitivity that has not yet become public, the parties might consider entering into a confidentiality or nondisclosure agreement that would permit the buyer to consider the matter in its evaluation of the seller, but still afford the seller assurances of confidentiality. (Schnase, 2004)
As with any other procedure, the initial due diligence process requires more than just going through the motions. The purpose of the due diligence inquiry is not to line the due diligence file. Information gathered should be read and assessed and any problems followed up and resolved. Moreover, there may be a real benefit to doing more than a "paper" due diligence and actually touring the seller's offices in order to better assess the seller’s resources, professionalism, atmosphere, and other intangible factors that may not be evident on paper. (Schnase, 2004)
Buying an existing business can be an excellent way to become a business owner or to expand your present business. You can save time and effort of building a customer and supplier base. You may also avoid the trouble of locating equipment and hiring and training employees. However, you should abide by the Latin slogan which translates “Let the buyer beware.” If you are not careful, acquiring an existing business can lead to disaster. (Poznak, 1998)
As a venture capitalists, it is wise to have your lawyer send out the due diligence checklist. Responding can be time consuming, so the list should go out in enough time for all parties to make all the necessary evaluations. Any lengthy delay in the due diligence process will delay or even potentially kill the deal. Make sure your lawyer is experienced and knows what to expect.
In addition to lawyers, it would also be prudent to secure the services of a consultant skilled in the type of business you are interested in purchasing or investing in. The consultant should be able to ascertain whether or not the company is well recognized in its market area and the potential for growth and profitability, by assessing the day-to-day operations. Are the employees skilled and trained in the area of expertise needed to remain competitive? And most importantly the consultant would need to evaluate the customer base. If there are a variety of customers, large and small, so that if one larger customer is lost, the impact will not adversely affect the entire operations. Lastly the consultant should inspect all the equipment to ensure the equipment is state of the art and has passed all state, DWV, local and OSHA inspections.
References
Due Diligence. (2000). Growing Pains Professional Advice. The KPMG Director. pg.25. Retrieved June 22, 2004, from EBSCOhost on Web site:
Global Law Review Legal Due Diligence. Retrieved June 22, 2004, from
Kumar, M. & Mathur, C. (2002, July). Legal Due Diligence. Retrieved June 22, 2004,
Mills, C. (2002). Legal Definition of Due Diligence. Retrieved June 23, 2004, from
Safe Conduct. (2001). Business Eastern Europe. The Economist Intelligence Unit. 30(44). Retrieved June 22, 2004, from EBSCOhost on Web site:
Schnase, L. A., (2004, January). Practical Tips for Managing Risk. The Investment Lawyer. 11(01)pg.17-24.Retrieved June 23, 2004,
Poznak, J. L. (1998, August). Buying a business: Let the buyer beware. Retrieved June 23, 2004,
