By Harold A. Laufer, Esq.

Before the purchase or sale of a business is completed, you should expect that an investigation into the business, its operations, financials, and other matters will occur. The buyer always wants to know that it is getting everything it believes it is paying for, and it will also want to be satisfied that the company’s prospects and problems have been independently identified without reliance on just the representations of the seller. The seller may not always like the extent to which a buyer will “turn the company inside out” but it is in the seller’s interest that no undisclosed problems arise after the closing. To the extent serious problems become visible after the closing, the seller will be at risk in several ways: the purchase price may be adjusted downward; any part of the purchase price held back at closing may be reduced or forfeited, and the seller may even get sued for breach of contract or misrepresentations. So due diligence is a very important and serious issue for both the buyer and the seller.

Once a buyer and seller have come to a basic understanding of the key points of a deal, the due diligence process will begin. Usually the buyer will provide a list of documents and issues it wants information about. The list can be in formal written form, verbally expressed, or consist of a series of communications bother oral and written. Due diligence checklists can run between a page or two to being dozens of pages long and, in a large complex deal, can consists of hundreds of items.

Usually, to get to a basic preliminary agreement, the seller will have already provided limited financial information to the buyer, but now much more detail about almost every aspect of the business and it operations will be examined. In even moderately sized transactions, it’s now common that an on-line data room be established so that documents can be reviewed without the need for a separate physical room containing hundreds of pages of materials to be made available.

So what are the main subjects of due diligence that as a buyer you can expect your advisors to recommend, and as seller, you can expect to undergo? Here are some of the key things that are looked at:

  • Can the assets or stock being purchased be transferred free and clear, or what liens exist?
  • Complete financials going back several years? Once it’s provided, can the financial information being disclosed be confirmed? What are the trends?
  • Are there too many key customers the company is relying on?
  • Are there major contracts?  When do they end and can they be transferred?
  • Are there key employees? Who are they and how are they incentivized to stay on?
  • Have all taxes been paid?
  • What are the employee benefit plans and are they all current?
  • What is the status of any real estate? Is there a mortgage?
  • Are there any environmental issues?
  • Are there bank loans and lines of credit?
  • Is there a union?

You can see from this list that a buyer will insist on knowing that it will get good title to the assets or stock it intends to purchase; that it wants to know how the company has been doing financially and what types of obligations it is accepting and the risks that it may willingly or unwillingly be forced to assume. A business owner that wants to sell his or her business needs to be aware that these types of issues (and more) will be looked at closely by any potential buyer. A sophisticated seller, or one who has experienced advisors, will think about how to manage the flow of information to keep the deal moving rather than stalling, and will think in advance about how to ameliorate problems which otherwise could hold up the deal or reduce the price. Finally, a seller that knows what he or she is doing will be careful about how they communicate any major issue which could blow up the deal, either before closing or, worse, create legal issues later.

Thinking about problems in advance, and how to fix, or at least minimize them, can make a big difference in whether the deal goes through and how much is paid. Every year Bradley & Gmelich helps buyers and sellers of businesses navigate all of the issues involved in getting their deals done.