The due diligence process is a critical part of every merger and acquisition transaction.  Ordinarily, at this stage of the transaction, the parties have established the general parameters for a transaction.  However, it is not uncommon to utilize the diligence process to bring to rest open terms.


What is the purpose of due diligence?  A buyer wants to thoroughly understand everything it can about its target.  This includes meeting with key personnel, beginning the process of negotiating definitive agreements, unearthing risks that must be allocated, justification for purchase price adjustments, the representations and warranties that will need to be provided by seller at closing, any open conditions to closing, and, items which may terminate the deal.

How do you develop a due diligence plan?  A lot depends on the structure of the target and areas of concern.  In addition, the time necessary to complete the investigation and the resources that must be made available to review liabilities, understand the transferability of customer and supplier relationships and obtaining the consent necessary for real estate, among other business points.

What are the common topics of diligence review?  The buyer must understand the charter documents of its target. What are the bylaws and governance documents and what do they say about the consent necessary to complete this transaction?  Material contracts must be reviewed, the financial condition and debt of the target needs to be understood. If real property is involved, title and related work must be performed.  Is there pending litigation?  Who are the parties and what is the potential exposure to the company?  What licenses, permits and regulation apply to the operations of the business?  Should environmental due diligence be performed?  A thorough understanding of any labor and/or employment matters, employee compensation diligence (for example, are there unpaid wages?), does the company own intellectual property?  Is it of critical importance to the deal?  Do intellectual property assignments exist?  And tax diligence should be performed.

What is the role of legal counsel?  The buyer’s counsel has two fundamental roles in due diligence.  First, the buyer’s counsel ought to take lead in insuring a thorough and efficient process.  At the end of the day, to the extent the diligence is inadequate or the product of diligence is unclear, this responsibility could rest with buyer’s counsel.  Second, buyer must review and analyze all the diligence material provided by seller and its counsel to understand the risks inherent in the proposed transaction.  The buyer should manage the online data room and prepare follow up requests as appropriate.  Direct communication between the buyer and the seller on matters of diligence can create confusion.  The buyer should work to manage the process to avoid this.

Seller’s counsel wants to prepare his or her client and its employees for an investigation and efficiently provide the information that is sought.  The seller’s counsel also has to manage any concerns relating to damage which could be caused by the inappropriate disclosure of confidential information.  Remember, part of the diligence process could involve disclosing confidential information about customers.  Should the deal not go forward, some buyers may be in a position to leverage the information they have obtained.  Seller’s counsel should work to mitigate these competitive concerns.  Seller’s counsel ought to be in a position to anticipate the amount of time diligence will take.  Often, the efficiency of the diligence process is limited by the lack of preparation on the part of seller.

What are the common mistakes made in the diligence process?  Often, the parties underestimate the time and resources a diligence process will take.  As a result, pressure is put on counsel and the deal to close despite the completion of diligence.  There may be strategic reasons to close quickly (availability of financing).  The risks of accelerating to close without adequate diligence ought to be addressed.

Second, I often see the parties underestimating the importance of a diligence issue to one party or another.  At times, a disclosing party may temporarily withhold information pending the resolution of some contingent factor.  The idea is that once the contingent factor is resolved, the diligence item becomes less important to the buyer.  However, should the contingency not be resolved, and the seller must disclose the material information, it could be perceived as a red flag and cause the buyer to engage in even more thorough diligence which could slow diligence and erode trust. 

Last, buyers sometimes mistakenly fail to rely on third party or alternative sources of information about a target company.  For example, if you are having lunch with an officer of seller, and notice an ankle bracelet, it would behoove the buyer to inquire as to the circumstance of the criminal restriction.  Obscure, yes, but illustrative of the importance of paying attention to information available that may not come directly from seller’s counsel.

Scott Levine | slevine@aegisps.com | Bio

Scott Levine | slevine@aegisps.com | Bio