#15690 - Due Diligence - Private Acquisitions

DUE DILIGENCE

Purpose of DD?

Obtain as much information as possible about the target
Allows B to decide whether or not to proceed with the acq, and if so, on what terms.
B will look to obtain information on:
- target's strengths and weaknesses
- areas requiring contractual protection (this will inform the types and extent of warranties and indemnities in SPA)
- identify consents needed (e.g. for the continuation of key contracts)
- identify potential costs of integration and plan accordingly

Areas to review

Business - Carried out by senior management of B and its business advisers

market position?
business plan and prospects?
will it fit in with B's business?

Financial - Undertaken by accountants who will produce a report outlining investigation

Review past accounts
Consider achievability of projections
Is further financing required?

Legal - Undertaken by legal advisers who will produce a report outlining investigation.

Any potential legal issues which may affect the value/prospects of target
Terms on which target does business
Extent of liabilities of target
Confirm the extent to which the target owns the assets used

Type of the DD report		Format of DD report
interim DD may be length and B may require interim reports summarising any issues of key importance. this will act as an early warning mechanism in relation to matters which may be so serious that B will consider withdrawing from the deal or renegotiating the main contract terms. full audit complete audit of the target business, including an in-depth summary of all the target's legal obligations. Very rare because of the expense and will only be required there B is concerned with the risks associated with the acquisition. by exception (for most transactions) focuses only on matters that are material to the proposed acquisition, or on matters that are unusual or unexpected.		Standard format: Executive summary sets out the key findings of the report. may also include key proposals (e.g. consents or conditions) which must be fulfilled before the acquisition can proceed, or terms which should be included on B's behalf in the acquisition documentation. Statement on Scope of investigation and liability B of shares or assets may have relied on the opinions of parties other than S (e.g. lawyers). If these turn out to be false or misleading, B may have a remedy against the third party. In the report there is, therefore, typically a statement as to the agreed scope of the investigation and any limitations on the liability of the advisors who have prepared it. Main report The main report will normally be divided into sections covering each area of the target business. Each issue will be identified, together with the results of that investigation and Explanation of risks involved and appropriate solutions.

interim

DD may be length and B may require interim reports summarising any issues of key importance.
this will act as an early warning mechanism in relation to matters which may be so serious that B will consider withdrawing from the deal or renegotiating the main contract terms.

full audit

complete audit of the target business, including an in-depth summary of all the target's legal obligations.
Very rare because of the expense and will only be required there B is concerned with the risks associated with the acquisition.

by exception (for most transactions)

focuses only on matters that are material to the proposed acquisition, or on matters that are unusual or unexpected.

Standard format:

Executive summary

sets out the key findings of the report.
may also include key proposals (e.g. consents or conditions) which must be fulfilled before the acquisition can proceed, or terms which should be included on B's behalf in the acquisition documentation.

Statement on Scope of investigation and liability

B of shares or assets may have relied on the opinions of parties other than S (e.g. lawyers).
If these turn out to be false or misleading, B may have a remedy against the third party.
In the report there is, therefore, typically a statement as to the agreed scope of the investigation and any limitations on the liability of the advisors who have prepared it.

Main report

The main report will normally be divided into sections covering each area of the target business.
Each issue will be identified, together with the results of that investigation and
Explanation of risks involved and appropriate solutions.

Procedure for DD:

Public searches

Review all public records of the target business or company
- Companies House
- Land Registry
- Land Charges Registry
- UK Intellectual Property Office
Commercial providers of information
Websites, trade press, etc.
Report from accountants

DD questionnaire

Forward detailed questionnaire to S's lawyers
Replies will be B's main source of information on the target business
Tailor the questions to the particular business

Interviews

Management questions
Site visits

Secure data room

Where information about the target is highly sensitive
Where sale is by way of auction
Provides access to data by way of a secured data room - S will make limited information available to B.

Scope of DD?

DD carried out by a number of different advisers
- Important to split areas of responsibility between them to avoid duplication of time/costs
Lawyer responsibilities = "Engagement Letter" which will set out:
- terms of the appointment
- areas of responsibility
- set up lines of communication between various advisers
- fees and limitations

The extent and focus of the DD required by the lawyer will depend on:
- B's knowledge of the target
- Type of transaction
  - private sale will have access to more information when compared with an auction sale.
- Structure of the transaction
  - share or asset sale? DD on all assets and liabilities, or focused on particular assets/liabilities

Focus of DD

Will depend on the following facts:

Purpose of the acquisition
1. Investment?
  1. potential for financial return?
  2. no barriers to realising investment?
  3. no hidden costs?
2. Growth?
  1. details and prospects of research and development?
  2. marketing arrangements?
3. Synergy?
  1. economies of scale?
  2. marketing advantages?
4. Risk assessment of target business
  1. industry risks
  - matters of concern will vary from industry to industry
  - a fruit beverages company, for example, will be more concerned with intellectual property rights, supplier contracts, and factory machinery and premises, than it will be with title to properties and planning restrictions.
5. Target specific risks

Past financial difficulties?
Previous litigation?
Reputation?
How it has been ran?

***Don't investigate areas which are of no importance to the acquisition***

Limitations of DD
Time constraints	Financial resources and manpower	Confidentiality	Third party confidentiality	B's own knowledge of Business
This is the most significant factor in determining Scope of B's enquiries. Short timescales or a S in a strong bargaining position may dictate limited DD.	B may be unable to commit sufficient financial resources or manpower to a full-scale examination of the target.	S may wish to keep the sale secret from outsiders (competitors and suppliers) and from its own workforce. S may also be reluctant to pass on commercially sensitive information. Grading of confidential info will mean that some info will not be passed on until very late (e.g. to protect info from workforce).	Some of the documents which B may wish to review (e.g. joint venture agreements) may themselves be subject to confidentiality agreements.	B may not fully understand the nature of Business or the market in which it is situated.

How should you respond to the findings of DD?

Renegotiate price
Contractual protections – Indemnities (reimbursement) / warranties (confirm there are no other issues)
Walk away

Common areas of investigation

Corporate Information	Search public records relating to the target: CoHo (or similar in other jurisdictions) articles and memorandum details of original allotment ownership of shares at last annual return Search property details at Land Registry or Land Charges Registry websites, trade press, commercial organisations which specialise in providing corporate/financial information about businesses Note: not always reliable - obligation to file at the CoHo is on the company, and although the company/directors are liable to fines, there is no provision for compensating third parties who suffer loss as a result of incomplete/inaccurate info.
Constitutional Documents	Company search will reveal articles and memorandum of the company: Are there any restrictions on the transfer of shares? Does the company have the power to dispose of its assets? Are the directors authorised to do so?
Annual Return	Check CoHo for the Annual Return, which contains details of: shareholders, directors and company secretary issued share capital of the company. Used to ensure the correct shareholders enter into the agreement, and as to the current directors, so that B can consider what arrangements should be made with them in completion (e.g. that some resign and others enter into new service contracts). Note: that the information may be out of date, so ask S's lawyers to provide details of all changes since the return date.
Internal Registers and Minutes	Check statutory books: Have company procedures been properly followed? Have allotments and transfers of shares properly carried out and registered in accordance with statute and articles?
Audited and Management Accounts	Check audited accounts for the last 3 years; and Recently produced management accounts. This will allow B to consider what warranties or indemnities should be included in the agreement as a result of the information revealed in the accounts.
Loans	Asset acquisition Existing bank arrangements of the target will cease and B will need to organise its own facilities. Enquire which relevant assets are subject to a charge as these will need to be removed on completion and query whether consent (e.g. of the lender) is required for the asset to be transferred.

Loans	Share acquisition Request copies of all loan documentation - nature and extent of the target's borrowing commitments/obligations. Check whether any loans are repayable on demand / entitle lender to demand immediate repayment on a change of control. Check whether selling shareholders have guaranteed any obligations of the target; S's liability will continue after completion, but B should anticipate that it may be asked to release S from such guarantees and indemnify S if the release is not obtained on completion. If the target is a member of a group, check whether it has guaranteed the obligations of any other members of the group as B will not want those guarantees to continue after completion.
Charges & mortgages	Asset acquisition A search at Companies House against a company disposing of a business will reveal whether there are any charges over the assets which are being transferred. Generally want any charges over assets released. Share acquisition B of shares will want to...

Loans

Share acquisition

Request copies of all loan documentation - nature and extent of the target's borrowing commitments/obligations.
Check whether any loans are repayable on demand / entitle lender to demand immediate repayment on a change of control.
Check whether selling shareholders have guaranteed any obligations of the target; S's liability will continue after completion, but B should anticipate that it may be asked to release S from such guarantees and indemnify S if the release is not obtained on completion.
If the target is a member of a group, check whether it has guaranteed the obligations of any other members of the group as B will not want those guarantees to continue after completion.

Charges & mortgages

Asset acquisition

A search at Companies House against a company disposing of a business will reveal whether there are any charges over the assets which are being transferred.
Generally want any charges over assets released.

Share acquisition

B of shares will want to...

#15690 - Due Diligence - Mergers and Acquisitions (Private Acquisitions)

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