A due diligence process seeks to reveal the potential risks hidden within a company. For this reason, it is widely and commonly used in company/business acquisition. While due diligence is recognized as a process of investigating, analyzing and assessing the relevant documents about the target company, for the purposes of the article, we will focus only on the process of conducting due diligence before buying a business.
What happens during due diligence?
Due diligence usually happens after a term sheet/memorandum of understanding has been agreed between the Buyer and the Seller but before a definitive purchase agreement is signed.
During the due diligence exercise, the Buyer’s lawyer will send out a due diligence questionnaire to the Seller. This questionnaire includes queries about the target company and its business. The purpose of this questionnaire is to extract all the relevant information from the Seller.
The Seller will then collate the information and documents and answer the questions in the due diligence questionnaire and send it back to the Buyer’s lawyer. Typically, the Seller creates a “data room” which allows the Buyer to gain access to the documents concerning the target company.
Next, the Buyer’s lawyer will start an investigation by reviewing and analyzing the documents to identify the risks, weakness and strengths of the target company.
Lastly, the findings and outcomes are documented in a due diligence report which includes an executive summary followed by detailed sections covering the areas examined in the investigation process. A due diligence report will provide the Buyer with a piece of in-depth knowledge about the target company, which can help you to make an informed decision whether or not to acquire the target company.
What are the typical due diligence areas?
Below are the standard due diligence areas that are most frequently examined:-
Financial due diligence
The financial due diligence involves checking the financial health of the target company to understand the current financial strengths and weakness of its business. The Buyer’s lawyer will generally look into, among others, the documents about the assets, financial structures, and more importantly, whether tax liabilities have been met.
Legal due diligence checklist
Legal due diligence involves examining a wide variety of legal documents ranging from board minutes to contracts in the target company—for example, employment contracts, the information concerning ownership of the target company and its constitution. Also, it is critical to check if there are any existing/pending legal disputes in the target company, which can surmount the Buyer with costly litigation.
Intellectual Property due diligence
IP due diligence involves examining the list of all IP assets owned or utilized by the target company that may include, trademarks, patents, copyrights and other intellectual proprietary rights to assess among others:-
- Do any patents cover the desired intellectual property?;
- Are the patents valid and enforceable?;
- Is the target company the registered owner of the patents?;
- Can the patent’s ownership be transferred to the Buyer?; and
- Is there pending litigation?
How long does a typical due diligence process take for SMEs?
The amount of time needed for a due diligence process varies depending on the complexity of the transaction, the nature of business and the size of the target company. However, the due diligence process for Small/ Medium Enterprises (SMEs) will generally take 1 or 2 months.
Who are the parties involved?
Parties involved in due diligence will very much depend on the nature of the target company, and the areas are to be examined in the process. Commonly, lawyers, accountants and bankers are always involved in due diligence because they are the best person and in the best position to review those complex information and documents.
Conclusion
It is worthwhile for the Buyer to cover all aspects during the due diligence and to detect any hidden problems which can harm the deal. In brief, the ultimate objective of due diligence is to enable the Buyer to gain sufficient knowledge about the target company and to deal with the problems identified during due diligence in the definitive acquisition agreement.
Are You Considering Either Buying Or Selling A Business?
At Chern & Co., we regularly support buyers and sellers in the sale or purchase of businesses from the due diligence stage through to completion. If you have any specific questions about Legal Due Diligence or wish to discuss any aspect of the process, please speak to our friendly lawyers at +603 6419 9511, or send us a direct message through the WhatsApp button on our website.
Disclaimer: This article is intended for general information and education purposes only and not to provide legal and professional advice.