There are many traps for an unwary seller in connection with a buyer’s due diligence investigation of a seller’s business. In this context it is critical that the seller’s professional advisors carry out due diligence on the seller’s business before the buyer conducts that same exercise. In this regard, the seller’s lawyers and accountants will need to do the following:
- Carefully review all documentation, reports, financial statements, tax returns, corporate records (including shareholder minute books, stock ledgers, organizational documents, and shareholder agreements), and material records and agreements for the business (collectively, the “Material Business Documentation”) to (i) identify and correct any issues or problems relating to the seller’s business and (ii) ensure that the seller will not be providing to the buyer certain confidential information that should only be provided when it is more clear that the transaction is very likely to be completed;
- Cause all of the Material Business Documentation to be assembled in a data room where they will be reviewed by the buyer;
- Engage a third party to provide a valuation of the business;
- Assemble and prepare a team of key managers of the business who will be responsible for meeting with the buyer and its representatives for purposes of addressing the many issues, questions, and requests they will have; and
- Assist the seller with each step during the process of completing the transaction, including the preparation and execution of a confidentiality agreement, a letter of intent, employment agreements and a purchase agreement.
While due diligence is often associated with a potential buyer’s analysis of the corporate records and material agreements of the business it is seeking to acquire (commonly known as the “target company”), due diligence is not a one-sided process. It is very important that a seller and its professional advisors invest a great deal of time analyzing all facets of the seller’s business before a potential buyer conducts its due diligence.
Problems that arise in the buyer’s due diligence investigation can affect the timing and the amount of the purchase price to be paid to the seller, and even the viability of the transaction itself. A careful review of the seller’s Material Business Documentation will enable the seller’s professional advisors to identify and resolve any problems that may exist before the buyer uncovers those problems during its own due diligence review. By conducting internal due diligence, the target company will be able to develop a complete picture of its business and resolve any problems that may exist and thereby minimize the length, risks and costs associated with the buyer’s due diligence review of the target company.
The buyer’s formal due diligence process generally begins after the parties have signed both a letter of intent (which describes the structure and material terms of a potential transaction) and a confidentiality agreement (which requires each party to keep confidential any information obtained from the other party in regard to the potential transaction), and it often continues until the transaction has been completed.
Many think of due diligence as a process where a team of lawyers very closely scrutinize all of the Material Business Documentation. However, legal due diligence is only one piece of the overall due diligence process.
In addition to engaging a law firm, typically the buyer will seek the assistance of accountants, financial advisors and environmental consultants. As the due diligence investigation can be a very time consuming, risky and expensive process for the target company, it is critical that the letter of intent place restrictions on the scope and duration of the buyer’s due diligence investigation.
While the parties negotiate the terms of a purchase agreement, the target company will be providing a large volume of documentation to the potential buyer and its professional advisors so that they may fully assess the state of the target company’s business.
The buyer typically gets access to these documents by conducting an on-site review in a physical data room that the buyer has set up in an office, or by reviewing electronic copies of the documents that the buyer has set up in a virtual data room that is accessible by computer. The type of data room used for the due diligence process generally will depend on the amount of documentation that needs to be reviewed, the amount of time available to conduct the due diligence review and the amount of money the parties are willing to spend on the transaction.
In the early stages of a potential transaction, the target company should assemble a team of managers who are the most knowledgeable about the inner workings of the company’s business. These individuals will work with the company’s professional advisors, as well as the buyer and its professional advisors, in responding to questions and document requests concerning the target company. The target company’s legal team will field and review due diligence requests and determine whether and when the company should provide certain information to the buyer and its counsel. Before the target company provides any documents to the buyer, the company should provide the documents to its legal team so they can review their terms and take inventory of all the documents being delivered to the buyer.
The target company’s legal team will prepare a due diligence checklist, which categorizes and summarizes of all of the Material Business Documentation that the target company has provided to the buyer. This checklist will assist the target company’s key managers and employees in determining whether the company has fully disclosed its Material Business Documentation to the buyer. The due diligence checklist will also assist the target company and its legal counsel in preparing disclosure schedules to the purchase agreement where the target company identifies certain information and documentation that was not provided to the buyer in the due diligence process.
The process of selling a company may seem daunting for an entrepreneur who has invested so many years focused solely on the growth of the company. Entrepreneurs often get so caught up in the business aspects of their companies that they forget about the regulatory and legal aspects of their businesses. As such, once you begin to give consideration to selling your business it is very important to engage a legal team to carefully evaluate and organize your Material Business Documentation and guide your company through the whirlwind known as due diligence.