Mergers and acquisitions typically involves a considerable amount of legal, financial tax and relevant industry due diligence by a purchaser. Consider a transaction where a buyer purchases a private company that sells products or services. The buyer would want to know what it is buying and what obligations it is assuming, but also data regarding the sales potential of the company. This is particularly relevant if the company's sales record is waning.
Due diligence regarding customer lists and sales data is incredibly important. A purchaser must understand the company's customer base, including the level of concentration of the largest customers and the avenues through which sales are generated. It is then important to determine the revenues from various customers, the terms of any sales agreements, whether there are any mechanisms to ensure customers will remain with the company upon purchase, among other considerations.
It can be daunting for a purchaser to wade into deep blue waters if proper due diligence is not conducted to determine what, if any, surprises are waiting in terms of being able to sell a product or service once the business is acquired. In acquisition transactions, due diligence allows the purchaser to identify risks that are not necessarily reflected on a target's financial statements, particularly if it is a private company. Knowing the sales potential of a company through due diligence affects the crafting and scope of representations, warranties and covenants in the purchase agreement and can provide crucial leverage in negotiations.
Consider a financial services company that has a list of ongoing clients. In this case, it would be important to know if the material customer relationships are shaky, have been destroyed, or never existed in the first place. From a business standpoint, if the cash flow from a business is not adequate, this would in part be connected to the sales history and financial forecasts of the company. As discussed in an earlier post, a buyer's investment into the deal is connected with the commitment of a deal. By neglecting to assess historical sales data and customer retention statistics, a purchaser may not be buying what it bargained for. Ultimately, due diligence helps a purchaser answer two important questions: (1) what are you selling and (2) will you still be able to sell it?
The author would like to thank Milomir Strbac, Summer Student, for his assistance in preparing this legal update.
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