These risks and opportunities can include:
Due diligence involves analysis, testing procedures, investigation and general enquiry into the aspects of the business being purchased. It’s not an audit, although some of the procedures are similar. Most importantly, it should be carried out by an independent and impartial specialist - one who doesn’t have a financial stake in the outcome.
Proper due diligence reduces the need to rely on the vendor’s contractual warranties, which can be costly to pursue. There are many types of due diligence, the most common being accounting and legal. Legal due diligence would generally cover a review of the following:
Accounting due diligence is more relative to the past and future trading operations of the company although there is often some overlap between the two. Accounting due diligence would look at, for example:
Due diligence can take as many different forms as there are types of investment. They can be relatively straightforward, such as analysing past dividend returns for a small stake in a publicly listed company, or complex when it comes to looking to purchase all of an existing company or business.
This variability means that a “scope” needs to be flexible and established to suit each assignment. A scope is an agreed set of areas to be included in the due diligence, with the intended outcome being that the purchaser has the opportunity to resolve any specific queries or concerns about the business. The scope is designed to include items that are relevant to the nature of the business as well as general topics. For example, an assignment recently completed by us related to a manufacturing business in the food industry. Our scope therefore was tailored to include not only general areas to do with customers and trading performance, but also specific areas such as compliance with legislation and certification covering food handling and weights and measures, as well as stock turnover rates and seasonality of sales.
Some of the other areas that may be included in the scope are:
Regardless of the type of due diligence undertaken, we place emphasis on taking a risk based approach to each assignment – this ensures that the highest risk areas are addressed systematically and thoroughly.
Conducting a thorough review of a business and its workings means that the parties conducting the due diligence are often privy to confidential information not otherwise available to the public. Don’t be surprised if you are asked to sign a confidentiality agreement or if you are requested not to take documents from the premises – this is normal.
We are often asked how long a due diligence should take and how much it will cost. There is no clear answer – the depth of the due diligence will depend on the perceived risks associated with the business and of course the costs will vary accordingly. Perhaps surprisingly, there is such a thing as too much due diligence – over-analysis can offend a target company to the point where they walk away from the deal. It is can also result in “analysis paralysis” that prevents you from completing a transaction or provides time for a better competing offer to emerge. Appropriate investigation and verification into the most important issues often must be balanced by a sensible level of trust concerning lesser issues.
Most purchasers conduct their due diligence before executing the sale and purchase agreement. Sometimes there are time constraints and this is not possible – in these cases prudent purchasers would want the agreements to allow them to back out of the deal if the subsequent due diligence has unsatisfactory results. Either way, sometimes the due diligence process reveals matters that need to be resolved before the transaction can be completed. If the matters can’t be resolved then the agreement needs to be renegotiated or even abandoned. While this may be disappointing for the parties, it is far better to be forewarned!
Remember, if it sounds too good to be true, it probably is.
Written by Suelen McCallum Senior Manager de Vries Tayeh