Business 101: Due Diligence
There are many stages in the purchase or sale of a business. Part of a new series on our website, this article is intended to help first time buyers (or sellers) understand key concepts which will arise during the transaction, with the focus of this article being “Due Diligence”.
“Due Diligence”: a catch-all term alluding to the process that Buyers undertake to familiarize themselves with the business and assets they are considering acquiring from a Seller.
Essentially, due diligence means doing your homework on something you are looking to buy before you purchase it. Though this is the language used for corporate transactions, it is no different than reviewing all of the features of a new car and making comparisons against other types of vehicles, or having a home inspection done on a house before locking in your offer.
During the buy/sell process, there is often a large information disconnect between the Seller and the Buyer. At the outset, the Seller typically knows everything about the business: the good, the bad, and the ugly. The Buyer, however, likely only knows a fraction of this information (and chances are, only the good/marketable things).
The due diligence process helps bridge this information gap, allowing the Buyer to learn more about the business, verify important information, and increase their overall comfortableness in proceeding with the purchase. As the due diligence process is occurs after the main elements of the sale have been agreed to (e.g., through a Letter of Intent), the Seller is also more likely to feel comfortable sharing information to the Buyer and the Buyer’s interest in the business.
That said, even with the comfort of there being a document such as a Letter of Intent backing the deal, there will likely be some things the Seller will not be keen to disclose, or may try avoid disclosing. To help combat this, Buyers should be as diligent and inquisitive as possible, pushing to receive as much information from the Seller as they can obtain before the deal closes. Additionally, Buyers can protect themselves by obtaining, either in the Letter of Intent, or in the terms of the final Agreement of Purchase and Sale, positive obligations for the Seller to disclose specified information about the business, such as financial statements for the past three years.
Between providing leverage to negotiate a lower purchase price or additional warranties from the Seller or, in the extreme, walking away from the purchase, the due diligence process is very important for a Buyer. This is why it is very important to have a team of trusted professionals backing you to ensure that all of the important information is discovered before you close the deal.
For Sellers, assembling a strong team of legal professionals can help guide you in responding to requests for information, solving problems which arise (either before or after discovered by a Buyer), presenting information to Buyers, and ensuring your interests and any information disclosed is protected.
Looking for a more in-depth review on the Due Diligence process and what it entails? We invite you to read our more comprehensive follow up article: “Deep Dive: The Due Diligence Process”.
Stay tuned for more articles in our Business Transactions 101 series!
Buying a business can be complicated. While none of these tips will guarantee you a successful purchase, they will increase the chances that your deal will run smoothly and close on budget. If you are thinking about buying a business or have already started the process, get in touch with a our experienced team of business lawyers at CARREL+Partners today.
This publication is for general information purposes and is not to be taken as legal advice. The information within is current only to the date of publishing. If you have any questions regarding article content, please contact the author(s) directly.