Due diligence is commonly defined as an investigation or audit of a potential investment to confirm all facts, such as reviewing all financial records, plus anything else deemed material. Due diligence refers to the care a reasonable person should take before entering into an agreement or a financial transaction with another party. From this definition, one might conclude that the due diligence exercise is exclusively in the prospective buyer’s interest and should, therefore, be driven by the prospective buyer. However, the picture is slightly more versatile and there are several practical implications for both prospective buyers and vendors. This blogpost highlights some of the implications to be considered by prospective buyers when conducting their due diligence on the target business.
- Prepare and ask the right questions
Every business sector has its own legal, financial and operational pitfalls. Therefore, any prospective buyer should get acquainted with the target’s business sector first. Prospective buyers should identify the core functioning models of the given sector and the potential risks resulting therefrom and document and information requests should be prepared on this basis. Experienced advisors having the necessary industry knowledge may be able to add considerable value to this early stage of the due diligence.
- Defining expectations
Besides getting an overview of the target’s business sector, prospective buyers should clearly define their own expectations regarding the target business to be acquired. This will help prospective buyers in determining what they would consider as deal breaker or key issues items in the course of the due diligence and would also serve as grounds for setting materiality thresholds. Clearly identifying key issues items and setting the right materiality thresholds may help prospective buyers in keeping due diligence workload and costs manageable.
- Allocating resources
Depending on the prospective buyer’s expectations regarding the due diligence, sufficient and properly qualified resources should be allocated to the different tasks.
- Clear timeline and flexibility
As with any large-scale project, it is crucial to have a clear timeline for the prospective buyer’s due diligence exercise. However, prospective buyers should be prepared to exercise some degree of flexibility in the process. Some vendors may not be as prepared to gather and provide information as others. Some reasonable information requests may result in the flow of an unexpected amount of information which takes time to process.
- Vendor’s restrictions
Prospective buyers engaging in a due diligence exercise should be aware of the restrictions on vendors when it comes to the sharing of information on the target business. Confidentiality obligations, data protection rules and competition law may impose serious restrictions the breach of which may entail significant legal consequences.
- Keeping records
In order to be able to utilize the results of the due diligence exercise in the framework of the prospective sale and purchase agreement, prospective buyers should keep appropriate records of their due diligence findings, the documents available for review in the data room as well as the answers provided in the course of the Q&A process.
- Confidentiality and Data Protection
Prospective buyers will most likely be asked by vendors to enter into non-disclosure agreements and vendors will share information on the target business only on the basis of strict confidentiality undertakings. What appears to be of a formal nature may have a significant impact in the course of disputes or investigations by competition and data protection authorities. Therefore, prospective buyers are well advised to strictly abide by the confidentiality obligations imposed on them.
In our next post, we will focus on practical implications for a vendor participating in a due diligence exercise.