Acquiring a Business: The Role of Due Diligence
What is Due Diligence
Investing into and purchasing a business can be highly rewarding. However, before you invest your hard-earned capital to purchase a business, you need to ensure that you’re going to get what you’re paying for. To do that, you need to do your “due diligence” – or, in plain English, you need to do your homework and thoroughly investigate and understand what you are buying. Doing your due diligence is critical. Through due diligence, you’ll be able to identify the opportunities presented by the acquisition and, perhaps more importantly, identify any risks.
Who Should Be Involved in the Due Diligence Process
The thought of doing your due diligence may fill you with dread as you flashback to your younger self “doing homework”. The good new is that you don’t need to do your due diligence alone – and, in fact, you shouldn’t. Where your knowledge falls short, you should hire professionals to fill in your knowledge gaps \and to help you review and understand the information that you collect during your due diligence process. In most acquisitions you’ll hire an accountant and a lawyer. However, depending on what kind of business you’re purchasing, you may also hire other experts that will add value to your due diligence process.
Scope of Due Diligence
To get the most out of your due diligence process, you should define the scope of what you’re looking to learn about the business you’re looking to acquire and based on the scope you define you would then prepare a due diligence request list to keep you on track. What you’ll ultimately examine depends on the acquisition. However, below, we’ll summarize six areas that you should almost always investigate as part of your due diligence process when acquiring a business.
Corporate and Transaction Structuring
One of the first matters to address is whether the current operating structure of the business you’re looking to acquire should be maintained or restructured. If you’re buying shares of a corporation, this would include an evaluation of the corporation’s constating documents (certificate of incorporation; corporate by-laws, minutes, etc.).
The structure of the transaction must also be evaluated. The buyer should consider whether it makes sense to acquire the entire business with all its assets and liabilities through an equity acquisition (such as the purchase of shares of a corporation) or rather purchase specific assets (intellectual property, real estate, machinery, etc.) through an asset purchase.
Financial and Tax Due Diligence
To evaluate the profitability of the transaction, you should review the financial statements of the business you’re seeking to acquire. Some things to examine when doing your financial due diligence include:
- Whether the financial statements audited?
- What do the statements reflect regarding the financial condition?
- Are future projections reasonable?
- What amount of working capital is required?
- What are the current expenditures and investments of the business?
- How much debt does the business have?
On a related point, the buyer should also review the tax history of the business by evaluating the tax returns for the last several years.
As part of your due diligence process, you should also review all material contracts to have a clear idea of the obligations of the business you’re seeking to acquire. These agreements must be evaluated to determine whether the closing of the transaction would entail a breach of any change of control or assignment restrictions included in such agreements.
An evaluation of any ongoing litigation or settlement negotiations is also mandatory to evaluate any potential exposure that may affect the you and the business post-closing. Some of the things that should be reviewed in this area include:
- Files for all active litigation
- Documentation on any settlements
- Orders, or judgments issued by courts or governmental agencies
- Description of any claims made against the business
The employees of a business are its lifeblood. No due diligence of a business acquisition is complete without a thorough review of the employees of the business. Some of the things you should examine as part of the due diligence process into employment matters includes:
- List of employees and copies of any employment agreements in place
- Identification of any key employees and their role in the business
- Description of any significant labour problems or union activities
- Information about any labour claims made in court
Property and Environmental Issues
Depending on the type of business the target company is engaged in, you may also need to have access to information and documentation regarding the business’s real and personal property as well as any intellectual property.
If you are considering the purchase of a business or have any question about the due diligence process or any other transactional matter, feel free to visit us online at Beganyi Professional Corporation or call us at 647-977-7749 for an initial consultation.