Let’s assume you have already entered into a Letter of Intent (LOI) or Memorandum of Understanding (MOU) to purchase an interest in a company and you already have a general idea as to what the purchase price will be. The way for you to ensure you are making the right choice and that your investment is protected is by conducting “Due Diligence”.
How do you conduct due diligence?
The scope and depth of your investigation will depend on a few things. Is the target company publicly traded or privately held? Are you a strategic buyer or a financial buyer? How is the purchase going to be structured? How many jurisdictions does the target company do business in? What sort of business is the target company in and are there additional risks associated with this type of business? Are there any industry norms specific to this type of deal?
Most importantly, what is your level of risk tolerance and what, if any, deadlines exist to close?
Generally, due diligence involves the buyer signing a Non-Disclosure Agreement (NDA) that will allow them to review the company’s financials, contracts and other documents that provide an overview of the target company’s health. The list of documents usually starts simple and then expands to include charter documents, material contracts, financial and debt instruments, ongoing or threatened litigation, required licensing or permits, environmental concerns, employee compensation packages, intellectual property, taxes, cybersecurity controls, social media accounts, etc.
Depending on the company, its size and industry, the due diligence will require going even deeper and hiring industry specialists to conduct onsite inspections, forensic accounting and company research. Specialists often include accounting and tax professionals and legal specialists in environmental laws, intellectual property, regulatory compliance, labor and employment, real estate, insurance, etc.
In order to know what is going to be involved you need to have an open and frank conversation with your counsel about how much time and money you’re willing to put into the investigation, discuss how you are going to divide out labor and responsibilities and have a firm understanding of any applicable time limitations.
The attorneys’ role often then becomes that of a project manager, checking in with the buyer’s specialists and seller’s designated agents to find out if necessary reports have been provided, requesting supplemental reports, maintaining a list of follow-up questions, all while simultaneously drafting and negotiating the underlying purchase agreement with opposing counsel.
The most common mistake when conducting due diligence is underestimating the time and resources necessary to complete such a project.
Examples of how this could play out: the Seller will inevitably argue at some point that the deal should be ready to close while the buyer is still trying to confirm that the Accounts Receivable and Accounts Payable match up; the Seller will claim that they have already provided all the information they have but will fail to mention that certain key information is stored in only one person’s head who just happens to be on maternity leave or is retiring next month; the Seller will state that there are no unknown liabilities while simultaneously trying to hold off a discrimination lawsuit or stop an unpaid wages claim; or in today’s environment, one of the parties may just be too embarrassed to admit they lost the passwords for the company’s social media accounts.
The key is to keep all lines of communication open so that if the situation on the ground changes you can bring people to help.
Word to the wise, never assume that every report is accurate or that all necessary document exists.
By John T. Van Geffen, Esq.
Avialex Law Group, LLP
San Francisco, CA
John T. Van Geffen is a partner at the Avialex Law Group, LLP specializing in litigation, aircraft and commercial transactions and regulatory compliance matters.
I am a partner at the Avialex Law Group, LLP, specializing in commercial transactions, business litigation and regulatory compliance in the transportation industry. While the firm generally handles matters within the field of aviation, our clients’ needs, and thus our practice, is extremely broad and
I am a partner at the Avialex Law Group, LLP, specializing in commercial transactions, business litigation and regulatory compliance in the transportation industry. While the firm generally handles matters within the field of aviation, our clients’ needs, and thus our practice, is extremely broad and I have extensive experience with corporate governance, intellectual property (NDAs, licensing, service agreements, etc.) and commercial transactions involving multimillion-dollar products with complicated service plans.Read more
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