Due diligence (“DD”) is a process enabling a buyer to ensure that any risks associated with buying a business have been properly identified and considered.

The DD process as a whole has historically been viewed as expensive and of limited benefit to a buyer. This is not the case any more. Over valuation has meant that the approach to DD has changed and the DD report has become an essential document and heavy reliance is placed on the results. DD serves a number of purposes including identifying risks and liabilities, meeting the banks’ requirements, addressing regulatory issues and, most importantly confirming the value of the target business.

The process will differ from transaction to transaction. Standard procedures can be followed to increase the efficiency of the process eg:

1. Select the right team The process is increasingly divided up among a number of different advisers. The scope of the review should be clearly highlighted so efficiency can be maximised and unnecessary tasks and questions are addressed. Consideration should be given as to which teams need to be briefed eg: lemployment; lproperty; lpensions; ltax.

2. Effective management; Whilst there may be a number of people working on pulling together the relevant information, there will always be a ‘team leader’ on both sides. This is often the lead corporate partner on each side.

Their roles are to effectively manage the sub-teams working on the information gathering, and to make sure this is done efficiently and within the time scales.

3. Process management; In a simple transaction, information may best be produced in bundles but, in complex transactions, particularly where there is a cross-border emphasis, DD is conducted electronically through data rooms. Data rooms are used by sellers to manage the release of documents to the buyers. Multiple parties can access documents at the same time. The seller can manage what confidential information is released and when.

4. The results; The DD report is produced by the buyer’s legal advisers from the information gathered.

The style of the report that a buyer will want, will depend on the size of the transaction and on whether external lending is involved.

5. The traffic light system; One approach for displaying the results of DD is the traffic light system. Each issue raised is assigned a colour eg: Green: for information only; Blue; further information required; Amber; an issue that requires warranty / indemnity protection; Red; material issue that needs to be addressed as it may affect the deal price or brings into question the transaction as a whole. The system provides for clear classification of each issue, acting as a reminder for the lead advisor when drafting indemnities / warranties into the main agreement.

6. Conclusion; It does not matter how many times a client has made an acquisition of a business, a DD investigation is essential to ensure it does not disclose any nasty, or expensive post completion issues, when it is often too late to rectify them.

For further information on the issues raised in this article, please contact Director and Head of Corporate Finance, Andrew Lindsay on 01904 561440 or e-mail Andrew.lindsay@lf-dt.com