Due diligence is a legal term that refers to the exercise of proper care and attention to avoid committing a mistake through ignorance. For example, an estate agent should trace previous ownership and make sure that a property is free and clear before selling it to a new owner.
In another context, due diligence is a comprehensive appraisal of a business undertaken to evaluate the commercial worth of the business. Due diligence is exercised to investigate assets and liabilities.
If you are thinking of buying a business make sure you know exactly what you are buying. There are many ways to buy a business, each with its own financial and tax advantages and disadvantages. For example, if you are contemplating buying a business that is incorporated would you consider simply buying the controlling shares of ownership? Or perhaps only the valuable “pieces” of the business such as its assets, trade name and customer list? In the first instance, you are buying shares in the company who runs an ongoing enterprise, its history, its contracts, its employee arrangements etc. It is called the “share deal”. In the second instance, you are creating a new entity established with the newly acquired assets. It is called the “asset deal”.
The same rules apply if you are thinking of setting up a joint venture. You should carry out due diligence of your counter-party first to avoid surprises after the deal is done.
No matter which option you are contemplating, whether the share deal, the asset deal or a joint venture, you should do your due diligence first. Typically, it involves carrying out financial due diligence in order to establish the value of the business to be taken over and the legal due diligence in order to establish the lack of legal irregularities such as the existing liens or pending claims.
Usually, the first problem lawyers face when they start the due diligence examination is the lack of comprehensive data from the seller. The sellers often do not want to disclose too much information in order to avoid additional questions from buyers. Sometimes it is a part of the sellers’ tactics, and at other times it may be an attempt to hide problems. Lawyers must be tough on this point because collecting all documents is of paramount importance. Lawyers must be sure that they have comprehensive information about the target company and so they can fully analyse the situation from a legal and tax point of view. There is no “one size fits all” solution and lawyers must adopt a very flexible approach.
No matter which role you are contemplating, whether buyer or seller, you will have a greater chance of success the more careful and persistent you are in investigating all the aspects of your transaction.
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