Before you finalize an agreement to purchase a company, undertake a thorough due diligence process in order to verify that the information presented by the seller is accurate and that there are no hidden liabilities. As a purchaser, you should structure the transaction as an acquisition of the assets of the company, rather than an acquisition of the stock or other equity interests in the company. If you acquire assets you don‘t need to acquire any liabilities attached to the assets. However, if you acquire the stock or other equity interests in the company, you will acquire all of the assets and the liabilities of the target company.
You should begin the due diligence process after all involved parties have signed a letter of intent (LOI). The LOI should provide for a due diligence period of sixty (60) to ninety (90) days and have the target company agree to provide the purchaser with access to all of the target company‘s records. Due diligence is a complex undertaking consisting of legal, financial, and operational components. By doing it correctly, you will minimize the risk of wasting your money on an unprofitable business, acquiring unwanted liabilities and headaches or paying far more than the true value of the assets.
Your objective in carrying out legal due diligence is to make sure that the target company is on a sound legal footing. First of all, you want to confirm that the business has been legitimately formed and that it exists. You want to understand the company‘s ownership structure, the rights of different owners, how it is managed and who has the authority to approve the transaction. You also should review agreements with key suppliers, key customers and key personnel. Find out if there are any pending or threatened lawsuits, or if litigation is likely to arise in the future. Check to see if the company‘s insurance is adequate. Verify that the company is in compliance with all applicable laws and regulations.
Your aim in doing financial due diligence is to verify that the financial information on which you base your buying decision and purchase price is accurate. You should gain a thorough understanding of the company‘s finances so that you can include potential contingencies in your projections and financial models. Find out if there are customer collection or cash flow problems. Check to see if there are unfunded liabilities such as pension benefits for current and future retirees and bonuses promised to employees. Depending on the size of the deal and your level of expertise, you may want to engage accountants or financial advisors to help you analyze the financial data.
Your goal in performing operational due diligence is to make sure that the target company will function as expected after you have purchased it. The business may be profitable now, but it might not be able to generate the same level of earnings after it has been acquired for a variety of reasons. The target company may be dependent upon key employees, key suppliers or a small customer base. Leases and loan agreements are often non-transferable, or may require the consent of the lessor or of the lender, even in the context of an acquisition of the stock or equity interests in the target company (which you should avoid anyhow). You should also verify that the company owns its intellectual property and trade names.
Why You Need to Consult an Attorney
Due diligence is a major project that involves scrutinizing an enormous quantity of information. Your approach to due diligence should be thorough, organized, and strategic. You should work closely with your attorney, accountants, and financial advisors to map out a strategy before you begin and get their advice at every step of the process. As you perform due diligence, you may uncover legal or financial liabilities or asset impairments in the target company that suggest it is worth far less than the seller‘s asking price or that make you think twice about acquiring the company. The cost of doing due diligence inadequately could be far higher than the cost of carrying it out properly.