During a business acquisition, a due diligence investigation is a must. The buyer is the party who has this investigation performed, to assess whether or not it will be a wise purchase. But what exactly does this investigation entail?
The meaning of due diligence
In Dutch, the term literally means "due diligence," which is of course appropriate in a business acquisition. In practice, it comes down to a book examination by the buying party. Every sale, acquisition or merger is different and emotions run high. This is why a book examination is ideal, because it looks at the facts.
What is the purpose of due diligence?
The goal is to identify the risks. The buyer largely relies on data provided by the seller. But before a buyer signs, he wants to know exactly what he is buying. Maybe the numbers were polished after they rolled out of the system? Maybe there is a chance of after-tax liability from the IRS? To get answers to those questions, the buyer conducts due diligence.
The seller has a duty to disclose, but the buyer has a duty to investigate at the same time. Both parties are responsible for sharing relevant information in order to bring the final negotiations to a successful conclusion. Should the buyer not spend sufficient time and attention on the due diligence, he will not be able to recover any damages from the seller and this may affect his legal position. Thus, it is essential that a buyer does not simply cross something off, but acts carefully. The communication between buyer and seller should be transparent and based on facts, but it is up to the buyer to ask the right questions.
What does the due diligence checklist look like?
The due diligence investigation goes beyond merely assessing the financial situation. One also looks at the commercial aspects, the IT part, but also the legal and fiscal state of the company. Is everything properly regulated and does it meet the legal requirements? You could divide the examination into the following categories:
- Basic data of the company. Think of personal data of shareholders, data of directors and managers, specifications of shares and an organization chart. Standard documents such as extracts from the Chamber of Commerce, articles of association and agreements should also be supplied.
- Financial data, such as specifications from the bookkeeper and accountant, tax returns, overview of any debts, rental and/or purchase agreements, lease contracts.
- Are there any pending lawsuits or suspected claims?
- What are the assets and ownership of the business? Are there any lease contracts? What about the inventory and stock?
- Intellectual property. Are there patent applications, trademarks? What about non-disclosure agreements?
- A complete list of personnel data so the buyer can see who is employed for how many hours and what the terms of employment are. All employment contracts, bonus schemes, insurance, pension contributions and third-party assignments should be on the table.
- Other issues, such as sales activities, market research, customer data from the last few years, competitive analysis.
AVG
An important aspect is the General Data Processing Regulation (AVG). The AVG plays a role in all phases of the acquisition process and it starts with the Non Disclosure Agreement (Nondisclosure Agreement). By necessity, a large amount of information is usually shared during due diligence. The seller sets up the data room and is responsible for it until the sale. Once the process is complete, access rights must be revoked. No copies should remain on laptops. It is almost inevitable that personal data must also be shared during due diligence.
During due diligence, the obligation to be as transparent as possible and the requirements of the AVG are often at odds with each other. Sometimes you can't escape sharing personal data. But in the beginning of the process, you share as little as possible. When it is almost certain that the other party will be the new owner, you share more information.
A solution from competition law is the so-called 'wet room' or 'clean room': a (virtual) place where you make information available that can only be viewed by a limited group. In this way you reduce the group that has access to personal data.
Finally, you can consider informing the works council that a transaction is imminent. However, this does not give you explicit approval for data sharing.
Renegotiate
Minor setbacks in the due diligence give the buyer ammunition towards the seller to lower the purchase price or tighten warranties and indemnities. However, do not view due diligence primarily as a tool for negotiating the purchase price. Undoubtedly there will be price lowering issues, but often in the letter of intent it has been agreed upon under what conditions a reduction in the purchase price is at issue. A buyer will have to conduct price negotiations primarily prior to the acquisition investigation.
Blowing off the deal
If the due diligence reveals major setbacks or unpleasant surprises, this may be reason for a buyer to cancel the acquisition. Yet in practice, this does not happen very often. The process is already far advanced and both buyer and seller have put a lot of time and energy into the acquisition. They would prefer to come to an agreement with each other. If the deal falls through, it usually has a financial cause: the figures were initially presented in a rosy light by the seller, but later turned out to be disappointing. Or the order book is anxiously empty just before the takeover, causing the buyer to get cold feet and withdraw.
It also happens that the buying process simply takes too long, causing the seller to become irritated and the chemistry to slowly disappear: the seller will no longer grant the buyer the transaction, will put his foot in his mouth, set hard deadlines and, if necessary, will call off the deal to look for a new candidate.
