Due diligence - what, why, how

Due diligence, also known as "DD", is a process that is often carried out in connection with the purchase and sale of businesses and shares. In this article, we will provide a brief introduction to what legal due diligence is, why due diligence is important and how both buyer and seller should prepare for, and perform, due diligence.

What is a due diligence?

In the legal world, the term "due diligence" is normally used to describe the review, examination and analysis of a business in connection with the sale of such a business. Due diligence can be of a legal, financial, technical, marketing, operational and/or regulatory nature, and can be carried out by both the buyer and the seller. The latter is referred to as vendor due diligence and is normally carried out as part of the seller's preparation for the sale of the business. Often, several parallel due diligence processes are carried out at the same time in one and the same transaction, such as legal due diligence carried out by legal advisors and financial due diligence carried out by financial advisors.

Why a due diligence is important

The main purpose of due diligence is, as far as possible, to ensure that all relevant facts about the business are presented to the buyer before the buyer and seller commit to the transaction agreement. Information presented to the buyer in due diligence will mean that the buyer is considered to be aware of the information presented and thus cannot subsequently assert a defect claim against the seller for such matters, unless the parties specifically agree that the seller shall indemnify the buyer for the specific matter. The seller is thus encouraged to present everything that may be considered relevant to the buyer in connection with the purchase of the business.      

By reviewing requested and relevant facts, information and documents, the buyer will be able to make a concrete risk assessment of the business and identify and mitigate the risk of unexpected legal and/or financial issues related to the business. For example, a due diligence can uncover and identify any violations of laws and regulations so that the parties can take the necessary steps either before or after the completion of the transaction to correct or prevent further violations. Furthermore, the analysis of the business can help the buyer to identify the company's contractual relationships, actual assets, liabilities, risks, rights and obligations, and determine or confirm the valuation of the company's business.

Any due diligence findings are normally reported to the buyer in the form of a due diligence report. The findings may have an impact on the further negotiations of the transaction agreement, typically in connection with the determination of the price for the business or shares, conditions for completion of the transaction, requirements for the seller's deliveries upon completion, guarantees and indemnities. The findings may also be matters that the buyer should continue to work on after completion of the transaction.

How to conduct due diligence

In order to achieve the most efficient and cost-effective process for the parties involved, the parties should make a concrete plan for how the due diligence will be carried out in advance of a due diligence process.

First and foremost, the buyer of due diligence should identify the scope, boundaries and objectives of the advisors who will carry out the actual review prior to commencement. In some cases, there may be areas of law or risk elements that the buyer is particularly concerned about, and which should therefore be given extra focus in the company review. Or vice versa - perhaps there are areas that are less important to the buyer and therefore not worth spending time and effort on. Sometimes, the buyer may also be better suited to carrying out parts of the due diligence themselves.

The buyer side will normally prepare a customized list for the target company with relevant questions and requests for documents and information related to the company that the buyer wants presented. These documents and questions typically relate to the company's foundation, governing bodies, shareholder relations, employees, contracts, suppliers and customers, debt relations, assets, intellectual rights, privacy, compliance with laws and regulations, property relations, insurances and disputes.

Once the sell-side receives the list of questions, the process begins with the collection of relevant documents and information that are posted in an electronic data room. Once the data room is deemed sufficiently clear, the buyer side is granted access to the data room and the content will be carefully reviewed by a team of legal experts and advisors to assess risk elements related to the business and uncover any irregularities. In most due diligence processes, the buyer and buyer's advisors are also given access to the company's management and given the opportunity to ask questions either in meetings or directly in the data room.

In a Vendor due diligence, the due diligence will be performed by the seller's advisors. The process is usually the same as when due diligence is carried out by the buyer side, but the purpose will typically be to prepare the seller side for what a buyer will be able to identify in its own due diligence, as well as giving the seller the opportunity to correct problematic conditions before a buyer is given access to the business. It is not uncommon for the vendor due diligence report to be presented to relevant buyers as part of the information package of the business.

In order to achieve the best possible due diligence process, our experience is that both the buyer and seller set aside sufficient time for the parties to carry out the most orderly and thorough due diligence possible. Furthermore, the parties should have an open channel of communication between them to be able to deal with any ambiguities or concerns that may arise along the way.  

The seller, on the other hand, should allocate sufficient resources and be well prepared for due diligence to avoid delays or potential pitfalls. This includes making resources available to answer the buyer's questions and requests. The seller should make sure that the data room is tidy and organized according to the list of questions. However, it is important to note that not all information should be presented to a buyer for competition law reasons. The seller's legal advisor will assist in assessing this.

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Due diligence can be a complex and resource-intensive process for both buyer and seller. In our experience, the key to success lies in careful preparation, transparency and collaboration with the advisors and between the parties to ensure that the transaction is carried out smoothly and with minimal risk for both parties. Before starting the DD process, the parties should also consider signing a confidentiality agreement that protects the target company and the seller's assets if the transaction is not completed.

At AGP, we assist both buyers and sellers in various due diligence processes on a daily basis, including preparing the process and carrying it out in the best and most efficient way possible.

Please contact us if you have any further questions about due diligence.

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