When buying a company, professional advice is always absolutely necessary so that you have a full understanding of exactly what you are taking on. In Teoco UK Ltd v Aircom Jersey 4 Ltd , the purchaser of part of a global management consultancy group claimed to have found itself facing millions in unexpected tax liabilities.
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:
- Identifying any issues or risks that could affect its decision to proceed with the transaction at all, or at the agreed price.
- Identifying any third party consents or other roadblocks that will need to be addressed before the transaction can proceed.
- Informing negotiations around the extent of the warranty and indemnity package required from the seller. The due diligence findings can be used to identify areas that require contractual protection and to flush out any risks that the buyer should avoid completely.
- Providing key information to assist in planning the integration of the target company with the buyer’s operations following completion.
- From the seller’s perspective, the due diligence process prepares the ground for its disclosure exercise by drawing together much of the information that it will need to prepare the disclosure letter.
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:
- Share capital and shareholders.
- Corporate structure and records.
- Finance and banking arrangements.
- Contracts and trading arrangements.
- Title to business assets.
- Real estate.
- Environment and health and safety.
- Intellectual property.
- Information technology.
- Employment and pensions
- Legal compliance and consents.
- Litigation and disputes
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.
Please call Martin Reynolds or Rob Jefferies on 0118 9589711 or e-mail [email protected] or [email protected] If you would like more information about the process or are not sure what assistance you need, we also offer a one hour fixed fee meeting for just £95 including VAT.