The honest answer… it depends on multiple factors, considered below.
In the context of buying a company, due diligence involves conducting careful research in multiple areas of the company or business you intend to acquire (such as financial, tax, legal and operational).
In this article, Kathryn Mansell of Old Mill and Jonathan Holloway of Trowers & Hamlins LLP consider the benefits of thorough due diligence for your acquisition strategy and how, as your trusted accounting and legal advisers, we can work together with you to mitigate risks in your acquisition.
How does due diligence help me?
In our experience typical benefits of thorough due diligence for you, as a buyer of a company (but equally applicable in the context of buying a business), include:
- Minimising risks: Due diligence can help identify hidden financial and legal risks that could impact the value of the company you wish to buy, such as outstanding debts, tax non-compliance or litigation. It can also flag accounting matters which could impact valuation, such as timing of profit recognition, or valuation of stocks and work-in-progress. You don’t want your purchase to turn out to be more of a liability!;
- Providing a better negotiating position: Knowledge of the financial and legal health of the business you are buying may improve your bargaining power in negotiations;
- Improved awareness of key legal arrangements: Detailed legal due diligence may, as examples, reveal important terms of key supplier or customer arrangements such as change of control provisions that need addressing pre-completion (or in some cases a review can highlight the lack of written contracts altogether). It may find that the company you are purchasing has ongoing litigation or competition issues;
- Time saving: Due diligence is more likely to reveal issues earlier in transactions that can be negotiated and managed in your purchase agreement. Without such a process, issues may only be identified later in the deal or following completion (where proceedings for breach of warranty claims will be more cost and time intense). It is much better to identify issues before completion;
- Smoother integration period: Conducting thorough due diligence generally improves your familiarity with the business you are acquiring. Our review may recommend post-completion actions including improvements in accounting processes and internal controls, or, on the legal side, a change of the company's constitution or a wider review of the employment or commercial arrangements to facilitate integration; and
- Maximising future opportunities: By reviewing the financial and legal data, you can uncover potential growth opportunities or financial advantages that could be leveraged to increase future profitability which you, as the new owner, might enjoy.
Great, but...
What does a good due diligence scope look like?
Exactly what questions you should look to answer during the due diligence process will depend on the business in question and your appetite for risk.
So what is my risk appetite?
Risks come in many forms and from many places – it is important to consider how the business you are buying operates so you can understand where the key risks might lie and what you want to focus on (and equally, those areas you are more comfortable with and do not require professional assistance to review).
For example, the company you want to buy may operate in food manufacturing, a high-risk environment with food hygiene and health and safety risks.
It could have had no claims in the past but also no policies or procedures in place to capture any risks.
On the other hand, it might have a dedicated team of individuals, policies and internal reporting which have identified hygiene problems, but subsequently sorted them.
Equally, you may be concerned with liabilities under key customer or supplier contracts and request specific help from us in this area.
Can I mitigate risk in my acquisition?
In short the answer is yes – as mentioned above, it is better to spot and address issues as far as possible before completion by thorough due diligence and we can work together to negotiate suitable protection in the purchase agreement with the seller's advisers, which includes.
- customary warranties from a seller in areas including the seller's ownership and right to sell their shares, accuracy of accounts, details on the company's finance and employment arrangements, recoverability of debtors and compliance with certain laws. The warranties elicit information which you may be aware of through your due diligence and may provide protection post-completion should an issue arise that you were not aware (and may be the subject of a warranty claim); and
- indemnities from the seller for known liabilities. For example, if the company you are purchasing has not complied with its obligations to its employees in respect of holiday pay or with data protection laws pre-completion or if VAT has been over-recovered, we would assist by seeking indemnities for you in the purchase agreement. Indemnities are generally easier to recover loss, compared to the time and expense of bringing a warranty claim.
By way of example of issues that can be dealt with through due diligence, it may be the case that:
- following review of the intellectual property position of the company you are purchasing, material intellectual property may not be owned by the company, in which case this should be transferred into the company pre-completion;
- following review of the property arrangements, there may be right of use issues or missed stamp duty payments which can be corrected and indemnity protection provided in favour of the buyer;
- financial due diligence may identify an overstatement of profit, which might lead to a renegotiation of the price or an unrecorded liability which will be adjusted through the completion cash/debt mechanism; or
- tax due diligence may reveal past errors that need to be corrected, with an adjustment through the completion cash/debt mechanism together with indemnity protection for the buyer for any potential penalties arising.
How can Trowers & Hamlins and Old Mill help me with due diligence?
Trowers & Hamlins and Old Mill can together assist with raising due diligence enquiries with the seller and their advisers across a wide range of areas and reviewing these with you. The level of professional support you receive in due diligence can be tailored to your risk appetite, mentioned above. You may prefer to have professional assistance on only specific areas that you flag to your advisers. Alternatively, we can offer a more detailed review, presenting key findings in a report.
Issues identified can generally range between key 'red flag' issues that we consider need to be addressed pre-completion and points that can be dealt with after completion. We can help you to understand risks in more detail and the likelihood of occurrence – and protect your position as mentioned above.
Both Trowers & Hamlins LLP and Old Mill have extensive experience conducting due diligence in a range of contexts (including share and business acquisitions) and tailoring the level of investigation to your requirements.
If you are considering buying a company (or business), please get in touch and we would be very happy to discuss your acquisition strategy and how we can help further.
Jointly authored with Kathryn Mansell from Old Mill.
Contacts
Kathryn Mansell
Corporate Finance Manager
Old Mill
DD: +44 (0)1392 351322
Jonathan Holloway
Associate
Trowers & Hamlins LLP
DD: +44 (0)1392 612345
M: +44 (0)7816 091807
