Irrespective of whether you are a first-time or seasoned buyer, the risks associated with purchasing a business need to be identified and carefully managed. This article delves into the critical role of due diligence and highlights three common legal challenges resulting from this process.
Business structure
The buyer should consider the method of acquisition prior to initiating negotiations with the seller. This will usually take one of two forms (or a combination of the two):
- Share purchase – this involves the acquisition of shares in the relevant entity that owns and controls the business (and, in doing so, results in the acquisition of its assets and liabilities); or
- Asset purchase – this involves the transfer by the seller to the buyer of the assets that are used to conduct the business. Sometimes an asset purchase will also involve the assumption of agreed liabilities.
Due diligence
Due diligence is the process by which the buyer, through a focused review and analysis of the target entity and its operations or the target assets, seeks to identify and mitigate actual or potential risks.
Due diligence is therefore both ‘forward looking’ – that is, to assess whether the proposed transaction is a strategic and financially sound investment – and ‘backward looking’ – that is, to confirm that the shares or assets which are the subject of the acquisition have a traceable history that accord with the law.
A buyer’s due diligence will typically involve:
- commercial and operational due diligence of potentially broad scope: including an assessment of the target’s management, infrastructure, systems (e.g., IT, software), processes (including risk management), culture, customer and supplier relationships and strategic positioning;
- financial due diligence: to confirm the historical financial position and performance of the target and the prospects of growth; and
- legal due diligence: to review the legal arrangements, identify existing or potential legal risks and, assess its impact on commercial and operational issues.
1. Intellectual Property
IP can comprise trademarks, patents, copyright, trade secrets and propriety software. For some businesses, IP is their primary or only asset. In such cases, the due diligence process should include an IP audit to check:
- the ownership and validity of the IP assets, whether registered or unregistered;
- whether IP is the subject of existing licencing arrangement; and
- whether the IP is freely transferable.
2. Regulatory compliance
It is imperative to evaluate whether regulatory requirements may impact the acquisition and, if so, whether the transaction documents should address the satisfaction of these requirements.
The due diligence process will assess historical compliance and the target’s ability to remain compliant. If there is evidence of non-compliance, a buyer may insist that completion of the transaction is conditional upon regulatory compliance, which may include:
- applications and approvals for essential licenses and permits; and
- employee and labour-law compliance (including settlement of any outstanding workplace issues or claims).
3. Contracts and agreements
A business may have existing contracts and agreements with suppliers, customers, employees, landlords or lenders.
In a share sale context, these contracts and agreements may contain provisions whereby a party cannot undergo a change of control without the consent of (or notification to) the other party.
In an asset sale context, these contracts and agreements may contain provisions whereby a party cannot assign the contract or agreement, or transfer or sell the assets under the contract or agreement, without the consent of (or notification to) the other party.
In such cases, the transaction documents must contain conditions that oblige the seller to gain the consent of (or notify) the other party to the contract or agreement.
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A thorough and well-structured due diligence process will uncover risks that must be brought to the negotiation table and effectively managed by way of considered contract drafting.
Carter Newell’s Corporate & Commercial team has experience advising buyers and sellers of businesses and companies and can help you successfully structure and complete a transaction.
This article may provide CPD/CLE/CIP points through your relevant industry organisation.
The material contained in this publication is in the nature of general comment only, and neither purports nor is intended to be advice on any particular matter. No reader should act on the basis of any matter contained in this publication without considering, and if necessary, taking appropriate professional advice upon their own particular circumstances.
