Due Diligence: Its Importance in an M&A Deal

Buying a business can be an extremely hectic and overwhelming process. One of the most important things for a buyer to do is understand what they are purchasing. The process of investigating and fully understanding what a buyer is purchasing is called performing due diligence. Due diligence is often the most time consuming and important part of buying a business. A due diligence checklist is a valuable tool a buyer can use to get started. A due diligence checklist will list specific pieces of information a buyer should obtain from the seller such as, a list of all assets used in the business, financial statements of the seller for the past three years, copies of all material agreements of seller, lien searches to determine if the assets being purchased are encumbered, etc. Most law firms have due diligence checklists which will vary, depending on the specific details of the transaction.

The due diligence being performed depends on a number of factors including, but not limited to:

1. buyer’s involvement in the business prior to the transaction (i.e., was the buyer an officer of the company being purchased?);
2. purchase price being paid for the business;
3. risk tolerance of the buyer; and
4. industry the business being purchased is in.

Sometimes due diligence is hindered by a lack of information available from the seller. If a seller is unable to provide information regarding the business being purchased, the buyer will need to assess whether they want to move forward with the transaction.  If the buyer decides to move forward, there are a number of ways to structure the purchase agreement in order to shift some of the risk back onto the seller including, but not limited to:

1. lowering the purchase price;
2. putting an escrow in place so that a portion of the purchase price is held back to ensure that no claims relating to the business arise for a certain period of time post-closing;
3. enhancing the representations and warranties given by the seller;
4. increasing the survival period for indemnification claims relating to the information seller is lacking; or
5. using an earn-out concept so that the purchase price is paid over time and is based on the success of the business post-closing.

If you have any questions or want to discuss how to structure your purchase or sale of a business, please contact Alicia Nicoletto or any other attorney in BrownWinick’s Corporate Practice Group.