Many buyers think of skipping due diligence as they believe they already have a clear understanding of the target company. But it is vital for buyers always to remember that there may still be aspects of the company which they don’t know about, or intentionally hidden from them. Hence, due diligence is a crucial stage in acquisition to identify the possible red flags before closing the deal.
In general, some of the most critical areas for due diligence comprise of legal, financial and tax due diligence. But for this article, we will restrict the topics by focusing only on the Legal Due Diligence. We will also be discussing why Due Diligence matters.
What is Due Diligence?
A Due Diligence is essentially an ‘investigation process’ conducted by the Buyer’s lawyers before buying a company/business to detect any potential exposure of the target company to corruption, legal and regulatory risks that may not be otherwise noticeable from surface perspectives.
In simpler terms, legal due diligence can help reveal hidden information about the target company, and to ascertain whether or not that target company/business is a safe bet. By allowing the Buyer’s lawyers to investigate into the affairs of the target company and reviewing all the relevant information and documents in connection with the company, the Buyer is able to gain a full and proficient understanding of the target company.
IMPORTANCE OF DUE DILIGENCE
Below are the importance of due diligence, and we will discuss why it should not be underestimated and taken lightly.
1. INFORMED DECISIONS
Generally, the Buyer will be inheriting all the liabilities of a target company. Therefore, it is imperative for the Buyer to conduct due diligence to seek to reveal material facts and potential liabilities of the target company for the Buyer to make better-informed decisions before an acquisition. This is significantly important because you wouldn’t want to be in a position where you later discover that the company/business bought is worth less than what you paid for. Or worst, you find yourself receiving an inheritance to the perpetuation of corrupt behaviour after closing the deal.
2. UNDERSTAND WHAT YOU ARE BUYING
Thorough due diligence can allow you to have a big picture of what you are buying and an analysis of any risks associated with what is being purchased. This includes the process of reviewing the licenses and permits, IP rights, commercial contracts/agreements and any potential challenges of the target company. It is wise and advisable for the Buyer to engage an experienced lawyer to try to find out any problems up-front before entering into an acquisition.
3. VALUATION AND NEGOTIATIONS
More often than not, if you are curious to find out whether the seller’s asking price is sensible. Due Diligence findings can give a good understanding on the current status and (poor) performance of the target’s company/business, which can often be used as an important bargaining tool to negotiate a reduction of the purchase price with the seller.
4. UNCOVER POTENTIAL LEGAL RISKS OF TARGET COMPANY
One of the main reasons why due diligence is vitally important is that it uncovers any past, current and potential risk as well as other ‘roadblocks’ concerning the target company to make sure nothing is concealed. So with all the necessary background information of the target company, the Buyer will be able to understand the potential risks and red flags issues to help you to stay ahead of the game.
In essence, while the process of due diligence can sometimes be time-consuming. Some of the issues flagged during this process can provide an excellent opportunity for the parties concerned to remedy those issues or give the Buyer peace of mind to proceed with closing the deal.
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 contact Mr Jonathan K. at firstname.lastname@example.org directly, 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.