The purchaser paid £41 million, less certain deductions, for two companies within the group. However, after the share purchase agreement (SPA) was signed, it claimed to have discovered that two overseas subsidiaries of one of the companies it had paid for owed a total of more than £3.4 million in tax. The group had provided warranties that the tax affairs of the purchased companies were in order.
The purchaser launched proceedings against the group, seeking damages for alleged breach of those warranties or an indemnity in respect of the alleged tax liabilities.
So what do they mean by due diligence?
Due diligence is the term used to describe the information-gathering process by which a prospective buyer investigates the target company and its business before making a contractual commitment to proceed with the acquisition. Through this process, the buyer aims to gain a complete picture of the target company and its critical success factors, strengths and weaknesses. The information obtained through due diligence will help the buyer to decide whether it wants to proceed with the acquisition and, if so, at what price and on what terms.
The buyer's due diligence exercise typically includes an assessment of the target's financial, legal and commercial position. It is usually carried out by the buyer's financial and legal advisers in conjunction with its own personnel. Depending on the nature of the target business, the buyer may also need to involve experts such as environmental consultants and surveyors.
Objectives of due diligence
Due diligence serves a number of important purposes for the prospective buyer, including:
Financial and legal due diligence
The financial due diligence will usually be carried out by the buyer's accountants or auditors. It focuses on those areas of the target business that are material to the buyer's decision to buy, so that the buyer can assess the financial risks and opportunities of the acquisition. Financial due diligence will usually lead the whole due diligence exercise.
Historically, accountants and solicitors have approached their respective parts of the due diligence exercise in different ways. The buyer's accountants will inspect the working papers of the seller's accountants and have lengthy discussions with the target company's management and its accountants. The legal due diligence tends to be carried out in a more remote fashion. The usual pattern of events is for the buyer's solicitors to submit a lengthy questionnaire to the seller requesting information on a wide range of matters concerning the target company and its business. The focus of the legal due diligence exercise can vary depending on the nature of the company being acquired. For example, if the target is a property company, the main priority will often be to carry out a full investigation of title on its key properties. For a consumer product company, the focus will often be on intellectual property rights, especially copyright and trademarks. If a consultancy is being acquired, the service contracts will need to be carefully analysed.
However, areas that are commonly addressed by a legal due diligence request include:
The legal due diligence tends to take longer to complete than the financial due diligence; principally because the information requested takes longer to source. This is particularly the case if the seller has not been properly prepared for the questionnaire, or if certain documents need to be extracted from the target company confidentially.
There will inevitably be some duplication between the financial and legal due diligence since the professionals are looking at different aspects of the same documentation, perhaps for different reasons. To keep duplication to a minimum and to prevent anything slipping through the net, good reporting lines must be established and there should be regular communication between the different teams of advisers involved.