What is commercial due diligence?
Commercial due diligence is the process of inspecting the business you are buying. It’s similar to buying a house —you do an inspection before purchasing the house.
The objective of due diligence is to have a full understanding of the target company’s liabilities and strengths, in order to be aware of the potential risks and calculate the Return on Investment of the business purchase.
It is important not to view due diligence as a mere formality. Conducting due diligence is the step in the buying process that is going to help you determine whether it’s a good investment to continue with the business acquisition.
Why is conducting M&A due diligence important?
Avoid risks when buying a business
When you conduct commercial due diligence, you reduce the risks of making a mistake when making an acquisition. You make an in-depth investigation to ensure the company you are purchasing is worth its price and that it is free of debts or other liabilities.
Keep the court in your favor
If you make an acquisition and the seller gives fake information about the business you’re buying, in order to enforce your rights, you have to go to court. Unfortunately, a court will not take your claims seriously if you did not conduct commercial due diligence before making the purchase.
It is very likely the judge will not act in your favor because it is the buyer’s responsibility to do due diligence in any Mergers and Acquisitions transaction. Conducting due diligence is the best guarantee a buyer has to prevent making a bad purchase or being a victim of fraud.
Write a solid purchase agreement
It is important to conduct due diligence because this process helps you gather all the information you need to write a solid purchase agreement. The purchase agreement should be written to protect you, but how do you know how to protect yourself when don\’t know the business risks?
For example, if certain equipment needed a certain level of maintenance to be functional, a buyer’s due diligence can uncover whether the seller was maintaining the equipment properly. This can also trigger the buyer to ask for warranties and representations about the seller maintaining the equipment. If the equipment goes bad after the buyer buys the business, and it’s found that the seller in fact did not properly maintain the equipment, the buyer can hold the seller accountable using the seller’s warranties and representations.
Commercial Due Diligence Process
The Commercial Due Diligence Report is a summary of the investigation of the target company. It is conducted on behalf of the prospective buyer, and it provides all the pertinent information the buyer needs to know before engaging in a negotiation. It includes all the relevant information regarding the internal and external environment of the company the buyer intends to purchase.
The Mergers and Acquisitions due diligence process includes three stages:
Initial Negotiations
In this phase, the prospective buyer and the seller agree to introduce a third-party firm that is going to conduct the due diligence process. The firm will do in-depth research on the target company in the best interest of the buyer.
Review of the due diligence report
The third party provides a complete report of the research to the prospective buyer. The firm covers every aspect of the target company that is of interest to the buyer for him to analyze and determine whether to continue with the acquisition.
M&A Due Diligence Checklist
Each due diligence checklist is going to be different based on the size and type of deal, but here are some basics every due diligence should have:
Corporation information
- Corporation/entity formation documents
- A list of all assets, including intellectual property
Financial
- Profit and loss statements/AR statements
- List of all bank accounts
- Tax letter clearance from the government
- Tax information and filings (e.g., tax election status, EIN)
Management and human resources
- All employee and independent contractor agreements
- Documentation related to benefit plans for employees, such as retirement plans and health insurance plans
Legal matters
- Bylaws, shareholder agreements/operating agreements, meeting minutes
- State and local licenses
- Past press releases and news reports
- Environmental licenses/documents, if applicable
- All contracts entered into
- List of liabilities, including potential lawsuits
- Insurance coverage documents
- Lease agreements
The Three Biggest Mistakes When Conducting Commercial Due Diligence
Not doing M&A due diligence
Not doing commercial due diligence is one of the most common mistakes a buyer can make in the acquisition process. If the buy-side does not carry out this part of the process, he could get into a disadvantageous deal, and, apart from making a bad investment, acquire liabilities and debts.
Not verifying information
The objective of the due diligence process is to ensure that what you buy is exactly what you were expecting. It is not enough to ask questions to the vendor but to verify if the information they are providing is real.
Not Using Due Diligence As A Basis for the Purchase Agreement
If your purchase agreement is too “boilerplate” or “standard” then it’s probably not taking into account due diligence. Make sure you actually use the information from your due diligence to write your purchase agreement. The research you conducted will help you understand which are the key points that you must consider to be protected through the purchase agreement.
How our Due Diligence Services can help you
Commercial Due Diligence is a key phase in M&A that needs the care of an expert. It is an intricate process that has to be carefully conducted in each of its steps, otherwise, it can lead to a disadvantageous negotiation.
With the help of Motiva Business Law’s M&A advisor, you don’t need to worry about conducting Due Diligence or any other part of the acquisition process. Our lawyer will take care of the Mergers and Acquisitions process and ensure you will have a smooth business transaction.
To have the support of our M&A advisory, call us at (630) 517-5529.