Getting a Handle on Due Diligence

If you are thinking about buying or selling a business the words ‘due diligence’ will often be bandied around.  The process of undertaking due diligence typically starts once a non-disclosure agreement is signed and clarity on the transaction is set. 

The process of due diligence is an investigatory one.  The purchaser is undertaking a deep review of the business they are buying to see if it is worthwhile.  So the purchase will undertaking the degree of problematic contracts, contingent future liabilities, strength of intellectual property, ongoing commitments and likelihood of forward cashflows. 

Legal due diligence considers the legal implications of the existing contracts.  This could extend to: 

Banking – Ensure that any security interest registered against the company is known.  If the company has any unusual or private interests from the owners these will need to be removed before due diligence is completed. 

Intellectual property – The ownership and right to trademarks, copyright and goodwill needs to be clear and unencumbered.  If the company has had historical reconstruction events the documented history of transferring IP needs to be clear, signed and on file.  

Property – Many leases require landlords consent before the control of a company can take place.  And it is surprising the number of landlords that will not agree to a change of control. 

Further, leases should be reviewed to identify any costly make good obligations or future rent increases.  If the leases are to associates of the vendor the lease terms are typically agreed in advance.  

Employees – The existence of long service leave contracts, accumulated leave balances, and workers compensation claims can quickly add up.  So ensuring that flexible workplace agreements are in place for transferring workers must be understood in advance. 

Insurance – Understanding the claims history of a company, pending insurance claims and the quality of existing cover will impact the decision to purchase a company.  The insurance policies should be reviewed by both a lawyer for the litigation work and also by an insurance broker for the quality of cover and potential forward costs. 

Licensing – Understanding the strength of regulatory licenses and standing with specialist government agencies is a must have part of the legal due diligence.  With the increasing range of licenses to start trading, quality assurance certificates and health and safety reviews the licenses and standing to trade and operate business requires a deep review.  

Litigation – The sale of a company will move across legal actions against the company.  So clarity on all legal claims and potential legal claims against the company are important as the purchase will typically have to manage the litigation for an event they were not connect with.  

The financial due diligence of a company will be concerned with the strength of forward cashflows and how much the purchaser can rely on historical information to predict the future cashflows of the business. 

Reconciliations – It is surprising the number of historical accounts that are not reconciled by the internal accounts team or there are no records that the accounts are reconciled.   

Getting access to proof the accounts agree to underlying documents and are reconciled is a cornerstone of financial due diligence.  If the vendor is audited by a registered company auditor this will provide the purchaser with greater comfort.  Alternatively, an information pack to a purchaser will give clarity on the strength of the internal team. 

Debtors and creditors – The investment in the working capital of a business is a major cost of purchase.  So understanding the investment into debtors and creditors, problem accounts and the amount of time invested into recovering debtors is an important part to understand the business being acquired. 

Cashflow forecast – A buyer of a business is buying future cashflow.  So providing historical, reliable forecasts, is an important part of showing a buyer the strength of future forecasts.   

If a business is seasonal the cashflow forecast is important to understand the investment into cash (or initial cash boost) to understand the purchase price. 

For a micro business that has poor records reviewing the bank statements for the last two years can help a purchaser reconstruct cash flows. 

Employees – With the large penalties now applied for missed, underpaid and late superannuation payments the investigation and reconstruction of the super guarantee levy is critical to understand the financial profile of an employee. 

Also reviewing undisclosed leave obligations and general HR governance for a potential purchase will form part of the due diligence checklist for any buyer. 

Taxation – The most likely ongoing dispute for many sales will relate to future tax disputes.  So reviewing past tax returns, tax workpapers, tax advice produced and Business Activity Statements will be a large part of the due diligence investigation.  If the company has international dealings getting written clarity on the offshore tax exposure is also critical to understanding the companies risk. 

The technical due diligence for a company will depend on the type of company involved.  For companies like technology businesses the technical due diligence is often completed once the financial and legal due diligence starts.  This due diligence will investigate the deep workings of the companies products, process and methods – it is ordinarily undertaken by an industry expert to ensure they final product delivered to clients is what is being represented to the buyer. 

Given that many questions asked by a purchaser as part of the due diligence investigation are common (and often common sense) a smart family in business will prepare a due diligence package for a buyer.  This pack will outline and pre-empt in detail the information ordinarily needed by a buyer and will significantly reduce the amount of time needed by a buyer on legal and accounting fees and will also increase the comfort by a buyer into the quality and depth of the business they are acquiring (so they are more likely to buy it). 

If you prepare a clear due diligence package prior to commencement a smart seller also has more time to prepare the information in a way that suits their purposes and their needs.  If information is produced reactively to a buyer due the heat of the due diligence process the likelihood is that ugly warts will start appearing – getting clarity on these items in advance with documented corrective action makes a world of difference. 

At Westcourt we have assisted a range of business sales and purchases ranging from micro sales to dealing with ASX top 25 companies.  Getting ready on the front foot makes a world of difference – starting the preparation for due diligence after the time has started always makes the process messy and can easily stop a transaction.  Given our experience, international reach and single focus we are a natural choice – so call us today.  

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