What is Due Diligence and why is it important?

Due diligence is a phrase often bandied about by lawyers, but what does it actually mean?

Legal due diligence is essentially an investigation into a business by a buyer or investor to make sure they are getting what they think they are paying for.

A buyer or investor will want to understand all of the obligations and rights of the business. This will include details of any borrowing or debts the business may have (or may be owed), any pending or potential disputes with third parties and any contracts that the business is party to (including contracts with suppliers, customers and employees).

How can a seller prepare?

Legal due diligence is usually thought of as an investigation performed by the buyer but it can also be an investigation into your own company.

Not only will pulling together the information at an early stage help you stay organised and save time when the sale process begins, it will also help you to understand the value of your business so you can stay ahead in negotiations.

It will also help you to iron out any sticking points before they arise e.g. if you don’t have a written contract in place then you could take steps to fix this or if you have poor credit control and a backlog of outstanding invoices you can start collecting these in to make your business more attractive to buyers or investors.

What should I look out for as a buyer?

Common issues to look for include:

Ownership: Who actually owns the business? In the case of a limited company this will be the shareholders in other businesses such a partnership this may be a little more difficult to ascertain.

Restrictions: Is there anything that may prevent a sale e.g. if only one shareholder is selling their shares do the other shareholders have any rights of first refusal or is there anyone that needs to give consent to a sale?

Contracts: Do you understand (and are you happy with) the terms of the business contracts? If not, what are the termination options? Are there any contracts which need the other party’s permission to allow the new buyer to take the seller’s place? This is particularly important for business sales where it is the assets rather than shares that are being sold.

Finance Documents: Does any company borrowing require a personal guarantee?

Tax: Is all tax paid up to date?

Due diligence is an essential part of buying or investing in a business and legal advice should be taken at an early stage.

If you would like to find out more about buying or selling a business please contact Louise at louise@ervinhall.co.uk and she will be happy to help.