Once key commercial terms have been agreed, there are three key stages in implementing a business sale:
- Due diligence
- The disclosure letter
- Negotiating the main sale documents.
If you are considering selling your business, it is important to get your house in order and prepare for the first stage, due diligence.
The legal due diligence process in a business transaction can be long. However early preparation by a seller will allow for quick and detailed responses to the buyer's due diligence requests which will ultimately assist in speeding up the process of the transaction and saving a seller in both time and legal fees.
What is legal due diligence and why do we do it?
Legal due diligence is the stage of a business sale where the buyer’s solicitors investigate certain legal affairs of the seller’s company. (This will normally be run alongside a financial due diligence process – although the legal due diligence will normally involve some work around tax and accounting matters, this will be more a case of verifying compliance than substantive analysis, which will be part of a separate financial due diligence process.)
Usually the buyer’s solicitors would send the seller’s solicitors a legal due diligence questionnaire. The seller’s responses to this questionnaire will help inform the buyer of any potential risks and rewards of the proposed acquisition.
The seller’s responses will help the buyer to decide whether they want to follow through with the purchase of the business. The buyer might also consider renegotiating terms of the acquisition to reflect any issues that cropped up as a part of its due diligence investigations.
Should the buyer wish to proceed with the transaction, the seller’s responses to the due diligence questionnaire will also assist the buyer’s solicitors in determining the scope of the warranties to be included in the share purchase agreement and identifying any risks that should be subject to specific indemnities.
We recommend that a non-disclosure agreement is in place before any information is supplied by the seller to the buyer or its advisers. It is also important to keep a clear audit trail of any information supplied to the buyer or their advisers, whether by email (or by access to the data room (see below)) once responses do start to flow.
Despite the above, sellers should not automatically assume that they have to disclose everything a buyer requests immediately. In particular disclosure of highly sensitive confidential information, particularly client details, can often occur at a relatively late stage in the process. Even if you have a non-disclosure agreement in place, it is very hard to ensure all information supplied is irretrievably deleted and cannot be used.
Why should you start early preparation for the due diligence stage?
Starting preparation for due diligence well before the transaction actually begins (for example, when you start discussions with a corporate financier) will lead to a smoother transaction process and ultimately save you in time and costs once lawyers are engaged.
It will also help you to identify any issues as early as possible and give you enough time to possibly resolve them or reduce their impact before any buyer uncovers them. A potentially difficult issue will be far easier to resolve if presented to a potential buyer at an early stage together with a credible explanation and workable solution, rather than the buyer discovering it for themselves after a price has been provisionally agreed.
What are the key areas that a buyer will ask about in a due diligence process?
The key areas to consider in a legal due diligence exercise are set out below. If you are a seller, you should start compiling any relevant documents as best as possible under these subheadings as early as possible. In doing so, you should be alert to the risks of disclosing personal data without due care and attention.
When collating information, sellers should try their best to organise information into a virtual data room using subfolders titled with the below subheadings. Greater organisation from the outset of the collation is the best approach.
- Corporate structure and records: are your statutory registers up to date for the company? Do you have records of board meetings and shareholder resolutions?
- Share capital and shareholders: do you have documentation in place evidencing any restructuring, share exchanges, etc.?
- Accounts: a buyer would usually like to see the company’s annual accounts and reports, management accounts and any budgets or forecasts.
- Finance and banking: a seller would need to provide details of company bank accounts and other finance/ banking related issues.
- Contracts and trading: this would include any business contracts to which the seller is a party among other things.
- Assets: the buyer would like to see a list of all assets owned by the company and any encumbrances against them.
- Intellectual property: this would include any details of IP owned by the company.
- Insurance: do you have policy documents and certificates of insurance for the company?
- Consents and compliance: do you have documents showing the company has abided by any compliance or consent requirements in its business operations?
- Litigation and disputes: you should compile any information of ongoing or threatened litigation or disputes involving the company.
- Employment: a buyer would like to see an anonymised list of all employees and directors of the company with certain information relevant to each employee.
- Retirement benefits: this would include documents relating to pension schemes.
- Real estate: a seller would need to provide information of any freehold or leasehold properties it owns or occupies.
- Environment: a buyer would want to see any environmental reports, audits or assessments relating to the company.
- Health and safety: this would include all documents relating to a company’s health and safety management system.
- Tax: this would include corporation tax returns and any other relevant tax matter of the company.
The above is the bare minimum of what would be expected in a due diligence process. Some of the categories may change as the transaction progresses. However having awareness early on in the process of what documents you have to hand is always welcome.
How we can help
The corporate and commercial team can advise across a range of issues, including mergers and acquisitions, brand protection and intellectual property. If you would like to discuss any of the aforementioned topics, please complete our online enquiry form.