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How does due diligence work during an acquisition?

  • Explain how due diligence works
  • Identify the different types of acquisitions
  • Identify the risks buyers and sellers should be aware of
CPD
Approx.30min
How does due diligence work during an acquisition?

The market is awash with acquisitions.

And one essential part of the M&A transaction is due diligence.

So what does it mean? 

Acquirers of shares or business assets will need to understand what they are buying before the deal can go ahead.

As such, due diligence is a phrase often used in the context of deal activity, but what does it actually mean?

Broadly, due diligence is an investigation by one party into the business and assets of another party.

It can take many different forms - from simple desk-top investigations using publicly available records, to full-scale visits to a business premises to look at every aspect of its operation. 

Buyer beware

Due diligence is important because whenever a person acquires shares or assets in a business the overarching principle of Caveat Emptor or “buyer beware” applies.

This means that if you buy an asset, English law dictates that it is entirely down to you to ensure you get what you are expecting.

Therefore, any well-advised acquirer or investor will undertake at least some form of due diligence before going ahead with an acquisition. 

The importance of due diligence usually depends on the nature of the transaction and the dynamics between the parties.

On a high value share acquisition, you can expect to see a significant level of legal, financial and commercial due diligence.

This is because the acquirer will take the company “warts and all”.

Liabilities

For example, the company may have a large tax liability or significant claim against it.

As the target company itself would retain these liabilities post-acquisition, it is vital that they are identified by the buyer before the deal is done to avoid potentially disastrous consequences. 

At the other end of the scale, a buyer may be acquiring assets from a distressed seller – for example, one that is going through an insolvency process.

Here, sellers (usually the liquidator) will be selling assets at a much lower value than they would be able to on a going concern basis.

The liquidator will know very little about the history of the business and will be looking to avoid personal liability. As such, the buyer will have very little information to go on and will invariably have to form a commercial view as to whether the benefits of the acquisition outweigh the risks. 

Share and asset purchases

In legal terms, there are also significant differences between a share purchase and an asset purchase.

A share purchase is where the acquirer buys the share capital of the target company.

With an asset purchase, the acquirer doesn’t buy the shares but instead purchases the assets of the target company – generally comprising goodwill, intellectual property, real estate, contracts, plant and equipment. 

While the acquisition of the share capital of a company means that the buyer will also acquire the liabilities of the target company, the position is different on an asset purchase where the buyer can generally “cherry pick” the assets and leave behind the liabilities. 

CPD
Approx.30min

Please answer the six multiple choice questions below in order to bank your CPD. Multiple attempts are available until all questions are correctly answered.

  1. True or false Caveat Emptor means it is entirely down to the seller to ensure the buyer gets what they are expecting.

  2. What is not included when a firm buys the assets of the target company?

  3. Why does Giles Dunning say that it is essential for both parties to enter into a properly drafted and legally binding confidentiality agreement, commonly referred to as a Non-Disclosure Agreement or NDA?at

  4. True or false, share purchase and asset purchase agreements will invariably contain comprehensive warranties given by the seller and addressed to the acquirer?

  5. Pick the odd one out. Legal due diligence looks at:

  6. What is the purpose of renegotiation of the purchase price following a disclosure that causes the buyer concern?

Nearly There…

You have successfully answered all the questions correctly, well done!

You should now know…

  • Explain how due diligence works
  • Identify the different types of acquisitions
  • Identify the risks buyers and sellers should be aware of

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