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Business Acquisition Guide. Importance of Legal Due Diligence

Business Acquisition Guide. Importance of Legal Due Diligence

It is important not to under-estimate the vital nature of a properly conducted legal due diligence process to the successful acquisition of a business trading as a going concern.  Therefore this article is intended to give Buyers practical information on some of the legal investigations, typically referred to as due diligence, they should consider carrying out when acquiring a target business, the aim being of course to reduce the likelihood of unpleasant surprises after the completion of the acquisition process.

Part I of this Guide gives a brief introduction to the issue and provides the Buyer and the Seller with a brief commentary of the importance of conducting legal due diligence as well as ways to minimize costs and unnecessary wastage of expense on professional fees if things do not proceed as planned.  

The Importance of conducting Legal Due Diligence

The due diligence process offers a great opportunity to gain as much background information and understanding about the business as possible. You would need to consider how the business is performing (sales, turnover and profits). The financial health of the business is crucial to your decision making.  Why the business is being sold; who the competitors are; past activities; track record and many more questions will need to asked and addressed.

The importance of conducting due diligence on a target business are two-fold.  Firstly, the legal due diligence process highlights both major and minor issues which can sometimes be overlooked by the less prudent Buyer intent of pursuing the acquisition of a target.  The process deals with issues such as legal ownership of the assets, contractual obligations of the business, the business structure, current or pending litigation or disputes involving the business, regulatory or statutory breaches, liabilities, debtors and creditors, the solvency and indebtedness of the business, existing borrowing of the company and its repayments, Taxation, HMRC investigations among others.

Secondly legal due diligence should uncover any issues with the business and thus act as an early warning signal to a Buyer informing the Buyer of issues which he or she is likely to face after the acquisition of the target business.  It can therefore act as aid for the prudent Buyer to decide what contractual protection he may need from the Seller most especially, the sort of risk he is not prepared to take based upon the information discovered as a result of the due diligence process.  

Exclusivity Agreements – saving costs

In some instances, the issues uncovered by the due diligence process are simply too detrimental to continuation of the process thus the Buyer may decide that the only prudent option in that instance is to withdraw from the transaction.  This is why we would always advise that where possible the Buyer should seek an Exclusivity Agreement. This is also known as a lock-out, shut-out or no-shop agreements.

An exclusivity agreement in this case would fulfill the following objectives:

  • It would ensure that the Seller negotiates solely with you for a period of time agreed by both of you.
  • Buys the Buyer some protection from known or unknown parties outbidding you
  • Buys time to conduct extensive due diligence
  • Can save you cost on expensive professional fees by providing some protection if the transfer proceeds due to no fault of the Buyer

An exclusivity agreement is important to the due diligence process and should be used when considering the conduct of due diligence on a target.

Conclusion

Many of the issues uncovered during the due diligence process can usually be addressed prior to the completion of the acquisition.  Therefore the information uncovered during the due diligence process allows the Buyer to obtain adequate contractual protection from the Seller and will sometimes lead to a remedy of such issues prior to completion as well as result in a successful integration of the new business following completion.

Therefore due diligence process (this is true of whatever type of due diligence being carried whether legal, financial, accounting or operational) will either uncover issues with the business or give the Buyer relative peace of mind to proceed with the acquisition knowing that all major bases have been covered.  

Part II will provide an outline of the actual process itself and the matters which typically are investigated during the process.

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