Due diligence – a must if you are planning to sell or buy a company

Are you planning to buy a company or merge it with another company? The due diligence process is a key step to help you uncover the true state of the target company. From financial analyses and legal audits to market risk assessments and corporate culture assessments, due diligence provides you with a comprehensive view of all opportunities and potential risks. Without a thorough due diligence, you risk unpleasant surprises that can jeopardize the success of your transaction.

What is due diligence (financial and legal due diligence of a company)?

The due diligence process, known in our country as an audit or due diligence of the company, represents the initial pre-transaction phase, in which the potential buyer, before the purchase of the company, thoroughly examines the state and condition of the company or the assets of the company being acquired, of which he has no or only very limited knowledge at this time. The buyer has the opportunity to familiarize himself with the real condition of the company before signing any purchase or transfer agreement, which can prevent negative impacts after his entry into the company.

Due diligence may be carried out on a limited basis, on defined issues of interest to the buyer. More often, however, we encounter complete or full due diligence, where the seller gives the buyer full access to information about the company and its operations.

This phase is the most crucial in the entire buying and selling process, especially from the perspective of the buyer or the party entering the company or the cooperation. The buyer has the opportunity to form a concrete picture of the company’s operation directly from its documents, by looking behind the scenesand assessing the potential risks of cooperation. Among other things, the buyer is able to identify risks, problems, strengths or weaknesses of the company based on due diligence, address these to the seller, and at the end of the day cover the findings in his favour within the transaction documentation.

Purpose of due diligence

The purpose of due diligence is to identify relevant findings about the company that are essential to the buyer’s decision regarding future cooperation with the seller. On the other hand, due diligence is an effective means of protecting the buyer, who, on the basis of the results of due diligence, is able to assess the merits of the transaction or even to define the extent of its involvement with the seller.

Initial expectations often start to be realised after the acquisition and the buyer encounters a number of pitfalls in the cooperation that he was not aware of with incomplete or completely absent due diligence. Such findings, once any documentation is signed, can fundamentally affect the dynamics of the relationship and jeopardise the buyer’s functioning in the company. These surprises can be easily avoided by the buyer if the buyer had gone through the due diligence process beforehand and requested the seller to disclose corporate information on the company’s operations.

Types of due diligence

The specific focus of due diligence depends on the buyer’s interests being pursued. Most often, legal, accounting, tax and financial due diligence is carried out in company acquisitions, where the main role is played by consultants and experts in the relevant fields. A special category is commercial due diligence, in which the buyer focuses on the company’s strategic indicators or customer portfolio or other benefits that would be beneficial to the business.

The subject of legal due diligence is a detailed analysis of the company’s corporate documents, contractual relations (mainly customer, supplier, employee, bank, lease), licenses, real estate and contractual documentation of the company’s assets , as well as control of the company’s regulatory obligations. In other words, legal due diligence focuses on compliance with the law as well as compliance with contractual and legal obligations, the breach of which may lead to the company’s liabilities.

Accounting and tax due diligence aims to identify potential tax risks or existing liabilities to tax authorities, or to catch irregularities in bookkeeping or tax payment that may lead to the imposition of penalties by the tax authority.

Related to accounting and tax due diligence is financial due diligence, which analyses profit and loss statements, balance sheets and cash flow, debt and liquidity, accuracy and consistency of accounting practices, or even forecasts and future financial potential. The objective of financial due diligence is to identify in particular the financial health and economic condition of the company.

How due diligence works

A buyer deciding to enter into a business transaction or contemplating the acquisition of a company should, after an initial expression of interest and initial discussions with the seller, request disclosure of information relating to the company from which to verify the facts asserted by the seller Based on the agreed scope, the buyer will approach experts with relevant experiencewho will prepare a list of requests for material information to be reviewed as part of the due diligence.

In the next phase, the information is collected by the seller, who, after completing the buyer’s requirements, discloses the required data to the buyer and its advisors via a dedicated secure electronic platform called a data room.

In terms of both time and cost efficiency, the buyer’s advisors conduct a review and analysis based on the information made available, processing all the data and presenting a summary of the identified findings to the buyer within a timeframe of days to weeks.

The output of the due diligence is simply a report for the buyer containing a list of findings, potential risks as well as a determination of the severity of the risk in terms of possible consequences.

Advisors who evaluate due diligence findings have extensive hands-on experience with the specific findings and are thus able to suggest solutions to protect the buyer should it decide to enter into a transaction.

When to approach specialists?

In almost every regular purchase, the buyer at least views the object of purchase and on the basis of, for example, inspection, considers the offer and decides whether to make the purchase, or in the case of the existence of a certain defect, negotiates a discount on the price.

The same is true for businesses, but in this case it is not just one thing or a set of complex information that is interconnected. Specialists and expert advisors are available to assist at any stage of the acquisition process. In the initial stages, they can define the level of detail required and what to focus on in assessing the risks to the company.

If the buyer or his employees do not have the expertise or capacity to review the company’s disclosures, a team of specialists can coordinate the entire due diligence process and inform the buyer of the findings at the final stage. The buyer can thus focus on the commercial and strategic aspects and leave the whole rather intensive and volume-intensive process to the specialists. Reaching out to specialists is ideally done as early as possible to give the buyer sufficient time to thoroughly investigate and address any potential issues.

In conclusion

Due diligence is a difficult and in most cases lengthy process, which is of crucial importance for the buyer. This phase is a necessity in business acquisitions and need not be a burden for the buyer as long as the buyer entrusts the process in the hands of specialists who are experienced in grasping and organizing the process and running it efficiently. For the buyer, the added value is the time and ultimately financial savings by identifying risks early and avoiding potential losses in the future.

If you are interested in this topic, please do not hesitate to contact us:

• Tomas Demo, e-mail: tomas.demo@highgate.sk

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