Buying a Business - Due diligence and identifying potential risks and exposures
Date: 28th November, 2016 | Author: Caroline Stark | Comments: 0
Business acquisitions typically require the purchaser to undertake a significant amount of due diligence. This invariably includes a thorough review of historic and current financial statements and testing of the future projections and underlying assumptions to check they are reasonable and believable. It is also critical to understand what obligations will be assumed, in particular, any ‘hidden’ contingent or inherent liabilities. Below is a summary of a number of areas of potential risk and exposure to consider for most acquisitions:
Employee/Management: an understanding of the quality of the management and employees will reveal any skill shortages required to take the business forward. Other specific areas to consider include the cost of dealing with any pending disputes or grievances; whether employees are offered any financial incentives; whether key people are likely to leave and if so what the cost is of finding a replacement.
Material contracts and agreements: these may take some time to review but could include guarantees, loan and credit agreements; customer and supplier agreements; employment contracts; licence agreements; or non-competition agreements. Consider the ongoing commitment and whether termination would materially adversely affect the business or whether change of ownership requires prior approval.
Intellectual Property (IP)/Technology: the extent and quality of IP is increasingly important and enquiries should focus on points such as: how the IP is protected; whether there has been any infringement of IP; is there any ongoing IP litigation or dispute; are there any liens or encumbrances on the IP e.g. registered charges; does the business rely upon trade secrets and know-how and if so what steps have been taken to protect this; identify what software and licences are critical to the business and ensure licence fees have been paid; check that the business is registered under the Data Protection Act 1998.
Customers/Sales: does the level of concentration of key customers cause any concern and will there be any issues in retaining customers following the acquisition? Are customers satisfied with their relationship with the business and its sales team or have there been unusual levels of complaints, returns or refunds?
Competition/Marketing: investigating the advantages/disadvantages of the business product and technologies as compared to its key competitors might indicate what level of future investment will be required to maintain levels of sales anticipated or the likely shelf life of products. Reviewing articles, press releases and the social media profile might reveal adverse publicity which could affect future trade.
Environmental/Health and Safety: this does depend on the nature of the business but audits by regulators and licences should be checked. If hazardous substances are used then disposal methods and the environmental impact should be reviewed. Have the health and safety and fire risk assessments been kept under regular review and are there any ongoing criminal investigations or outstanding fines?
Litigation: is the business subject to any pending or threatened litigation? This could include non-compliance in respect of any regulatory requirements. Indicators include unsatisfied judgements, statutory demands or prior notice of the intention to take control of goods.
The above is only a brief summary of some of the finer points to consider as part of carrying out the due diligence review of an acquisition target. Planning the due diligence review carefully and properly anticipating the potential risks and exposures that may arise will assist the purchaser in evaluating and negotiating completion of the acquisition.
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