Due Diligence & Disclosure
The due diligence and disclosure processes are important aspects of share and asset purchases, both from the perspective of the buyer and the seller. In addition, due diligence may also be carried out by an investor (often considering itself to be in the shoes of a potential buyer) before investing in a company or business.
Importance from the Buyer's Perspective
The much discussed principle of caveat emptor (buyer beware) applies to the purchase of a company/business. Therefore if you are considering a purchase, it is vital that you know exactly what you are purchasing so that unpleasant (and potentially costly) surprises in the future can be avoided.
The aim of the due diligence process is to provide a buyer with all the information it may require about the company/business it is proposing to purchase. The process will also highlight potential problems within the company/business so that the buyer and its advisers can consider whether the problem:
- should be remedied by the seller before completion;
- can be remedied after completion for an acceptable cost;
- justifies a renegotiation of the purchase price;
- requires amendments to the contractual documents; or
- leaves the buyer with no choice but to withdraw from the purchase.
The due diligence process provides vital protection for a buyer and its importance should not be underestimated. All of the information and documentation requested from, and disclosed by, the seller should be carefully reviewed, together with the disclosure letter (discussed below), and enquiries should be raised if the buyer has any concerns, or if further information is required about any matter.
Importance from the seller's perspective
Firstly, a seller needs to pre-empt the inevitable information request which commences the due diligence process. All sellers should ensure that their corporate/business documentation is in order and can be clearly identified and easily located before the sale process begins. If potential problems can be remedied before the sale process begins, this can save considerable time and cost.
Secondly, the key document in a company/business sale is the Sale and Purchase Agreement which will contain a number of warranties. Warranties are promises given by the seller to the buyer in relation to the business and the assets being sold. By way of example, the seller may be required to warrant that the company/business is not currently involved in litigation of any kind.
The main purpose of the warranties is to encourage the seller to disclose information to the buyer, so that the buyer has a full picture of the company/business it is purchasing. If the above 'no litigation' warranty was a true statement, then the warranty could be given by the seller without any further action being required. However, if the company/business was involved in litigation, the seller would need to make a disclosure against that warranty in the disclosure letter (see below).
Failure on the part of a seller to make a proper disclosure against a warranty, where the warranty is untrue, may result in legal action for breach of the warranty following completion. Clearly, this is undesirable and potentially extremely costly. For that reason a thorough review of the warranties, and a consideration of any potential disclosures, should be a priority for sellers and their advisers.
The disclosure letter
The disclosure letter is a letter providing information from the seller to the buyer, usually divided into two main sections. The first section includes the general disclosures, which detail those matters which the seller is deemed to have disclosed about the company/business. For example, the contents of a company's file at Companies House and the content of a property search would usually be deemed to be disclosed.
The second part of the disclosure letter includes the specific disclosures, which are the detailed disclosures against the requested warranties. The relevant specific disclosure to be made in this section of the letter against the 'no litigation' warranty discussed above, for example, might be to provide details of a claim by an employee for an accident at work which resulted in that employee suffering a broken leg.
Annexed to the disclosure letter is the disclosure bundle. This bundle includes documentation which is relevant to the disclosures which have been made. In the above example, correspondence from the insurer confirming that it is dealing with the employee's claim on behalf of the company/business would be useful.
Conclusion
The requirements, priorities and intentions of a seller and a buyer when carrying out the due diligence and disclosure process differ vastly. However, the process is fundamentally important to any company/business sale or purchase whether you are a buyer or a seller. Each party should ensure that they are receive professional advice so that any potential risks can be mitigated, avoided or, at the very least, recognised.
For a confidential, no obligation discussion about selling or buying a business, please email or call Mike Watson on 023 8082 0546.
Trethowans has experience of advising on all forms of corporate transactions. Partner Catherine MacRae and the team work closely with clients to achieve their objectives in the most commercial and cost-effective manner. They act for businesses throughout the South, including household brand names.
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