Due Diligence: What you must do?
When buying a business in Australia, it is imperative that you obtain legal advice from a commercial lawyer who will review the transaction and conduct due diligence.
Due diligence is an essential process that can help to minimise your risks and save you a lot of money. It is a process which is typically used in mergers and acquisitions. It is the fact-finding stage of purchasing a business and is used to clarify the business’ position and reduce uncertainties.
Before committing to the purchase of a business, you should confirm the business’ assets, liabilities and risks. These include the business’ intellectual property, security interests and potential lawsuits. It is particularly crucial in purchases involving private companies as they have not been subject to the inquiry of the public markets and where the purchaser has little capacity to find the information required. Thus, to confirm the viability of the business, a thorough due diligence process is necessary.
If you are a purchaser or a vendor, we strongly recommend that seek guidance from an experienced commercial lawyer. The commercial lawyers can guide you through the entire transactions and the due diligence process, as well.
Areas in which to conduct due diligence:
When purchasing a business, you need to know the business’ financial position. It is to consider is the target company’s past financial reports and financial figures, as well as the target company’s forecasts of its future performance to know the business’ viability into the future. The due diligence may include the following questions:
– What is the business’s current financial situation?;
– What does the business’ yearly, quarterly and monthly financial reports for the past three years reveal about its financial performance?;
– Have the financial reports been reviewed or audited?;
– Do the financial reports and other statements set out all obligations of the company?;
– Are the prospects for the business increasing or weakening?;
– Are the company’s forecasts for the future reasonable?;
– What amount of working capital is required to keep the business up and running?;
– What capital expenditures will be needed to make the business grow?
– What does the balance sheet tell about the assets and liability?;
– What are the outstanding financial obligations and what are the terms of repayment?;
– Are there any issues with the accounts receivable?;
– Are there any discrepancies with the EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) adjustment and is it calculated correctly?; and
– Does the company have the adequate financial capital to continue operating between the time of due diligence and the expected closing date of the acquisition?
2. Technology and Intellectual Property:
Intellectual property and technology are essential assets of a business, and it is important to ascertain which technologies and intellectual property are included in the business acquisition. The due diligence may consist of the following questions:
– Does the company possess any domestic or international patents?;
– Has the company taken any measures to protect their intellectual property?;
– Does the company have a trademark or a service mark?;
– What product does the company use, control or own?;
– Has the company infringed upon the intellectual property of third parties?;
– Is the company involved in litigation relating to intellectual property?; and
– What licenses does the company hold to use the technology and how critical are they?
It is essential to know and explore the customer base that you will be acquiring upon purchasing a business. The overall value of the business will be impacted by which customers will remain with the business after the acquisition. Even if they do stay, it is prudent to explore what keeps the customer base stable and attracts them as current customers. The due diligence may include the following questions:
– Who are the top customers and what amount of revenue is generated from the segment?;
– What issues can occur in maintaining the customers after the acquisition? Are the customers happy with the current managerial team?;
– Are there any warranty issues with customers and are there any backlogs?; and
– What are the terms and policy of sales and has there been an irregular number of returns, exchange or refunds by the customers?
4. Purchaser’s strategic fit:
A merger or acquisition is carried out by a business to either increase their market share or to develop a competitive advantage. However, sometimes business’ try diversifying by acquiring other businesses in different industries. You should consider how the business will fit in with your commercial portfolio. The due diligence may include the following questions:
– Does the company strategically match your brand portfolio?;
– Does the company possess product, services or technology that the purchaser does not have?;
– What about the key people and will they be retained after the acquisition?;
– What is the strategic benefit of the purchase?; and
– Will there be any revenue growth after the acquisition?
One of the most time-consuming but critical aspects of due diligence is the evaluation of all contracts of the company. It is essential to understand the state of the contract and its obligations after the purchase. The contracts that are important to analyse are:
– Loans or Credit agreement;
– Customer and service agreements;
– Company structure agreements;
– Legal Settlements;
– Previous mergers and acquisitions;
– Equipment’s agreements;
– Employees’ agreement;
– Real estate, licenses, Equity finance, other asset contracts;
– Sales and marketing contracts; and
– Other legal documents
6. Employees and management:
Employees are the backbone of the business, and it is necessary to evaluate the available resources after the merger or acquisition as the cost of new hire and retainment, are high. The employees and company structure which will be acquired upon acquisition need to be explored so that one can gauge the true value of the business. It is important to evaluate several issues to know the quality of the company’s employees and management capabilities by considering matters like:
– The company structure;
– Labour disputes;
– Agreements of employees, consultants, loans, transfers of officers and other key employees;
– Compensation, bonuses and other benefits;
– Stock options in relation to regulation by the ATO;
– Any need for further training;
– Any criminal proceedings or civil litigations against the employees;
– Actuarial reports; and
– Will employees’ redundancy and relating issues after the acquisition concern the activity of the company?
It is crucial to understand any legal issues or litigation against a company before committing to its purchase as the overall value and price of the business will be impacted by any litigation, which is occurring. The enquiry should include an understanding and analysis of:
– Any lawsuit that is pending or settled, along with the terms of settlement;
– Legal matters involving the company; and
– Government proceedings from ASIC, ACCC, Fair Works, etc.
The taxation implications of acquiring the business and tax structuring implications need to be considered to evaluate any compliance burdens that purchaser will be facing upon the acquisition. The following may be required in the due diligence process:
– An understanding of tax carry-forward rules is necessary;
– Tax return filed in past five years from the federal state, local and foreign income;
– Any discrepancies in payment of taxation or notices from the federal, state or local tax offices;
– Analysis and understanding of the tax position, tax compliance and reporting obligations;
– Tax treaties;
– Tax rules and laws and their application to the target company’s structure / new company structure; and
– Any tax controversy issues.
9. Regulatory matters:
To successfully, purchase a company, the purchase must comply with certain regulations. Anti-trust, anti-competitive or regulatory scrutiny is often the cause of fallout in a mergers and acquisition deal. The following steps can be taken to avoid a fallout:
– What anti-trust issues could occur?;
– Will regulatory permission to enter the deal be granted?;
– Has the company ever been involved in an anti-trust or regulatory scrutiny; and
– Where the purchaser is the competitor of the company, are there any limitations imposed by the company or the regulatory body to dismantle monopoly structure?
It is vital to understand any insurance policies that the target company possess, including:
– Liability insurance;
– Director & Officers insurance;
– IP insurance;
– Health insurance;
– Vehicle insurance;
– Errors & Omission insurance;
– Key Man insurance; and
– Compensation insurance
The article above is intended to be used for educational purposes. MistryFallahi Lawyers and Business Advisors would like to acknowledge the fact that due diligence process and questions are subject to the industry and many other factors affecting a business. For more details, please contact us.
At MistryFallahi Lawyers & Business Advisors, our lawyers work closely with advisors to navigate the complexities of the business environment. To ensure that you are asking the right questions and are getting required information for your potential purchase, please feel free to contact us to assist you and your team in developing acquisition strategies and any commercial litigation matters.
Please contact our legal team to discuss your business-related questions and how we can help you and your team on +61 2 8094 1247 or email us at firstname.lastname@example.org
Ehsan acts as legal counsel to entrepreneurs and is dedicated to maximising value, reducing risk and devising exit strategies. He has advised local and international entrepreneurs in industries such as information technology, property, telecommunication and e-commerce.
His main areas of practice are commercial law, asset protection, property law and technology.