26 October 2023

The importance of due diligence in the acquisition of a business

Matthews Folbigg Lawyers


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Due diligence is the process undertaken by the purchaser to assess potential risks when acquiring a business.
Australia Corporate/Commercial Law
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Due diligence is an integral step in the acquisition of any business, whether the transaction is an asset purchase or a share purchase. If done correctly, due diligence helps mitigate the various commercial, financial and legal risks that a purchaser may otherwise be exposed to when acquiring a business. Due diligence is the process undertaken by the purchaser of a business to perform an assessment of risks and compliance to ensure that the target business is, amongst other things, profitable, compliant with its legal, including contractual, tax and other obligations and operating with appropriate licenses and approvals.

The process of due diligence can be extensive and robust depending on the nature, age and size of the business. It involves reviewing, investigating and obtaining appropriate professional advice on various aspects of the business, and verifying the information provided and representations made by the vendor.

When should due diligence be conducted?

While it may be preferred to commence due diligence before entering into a binding contract, the vendor may be reluctant to share sensitive business information prior to an agreement being concluded between the parties. It is therefore common practice for parties to enter into a separate due diligence deed with the necessary confidentiality provisions, or for the sale contract to be drafted such that due diligence is a condition precedent to the sale. This will give the purchaser the right to terminate the contract if the outcome of the due diligence is unsatisfactory.

Types of Due Diligence

The types of due diligence will vary depending on the nature of the business being acquired. Generally, due diligence should be conducted in the following areas:

  1. Commercial and operational

    Commercial due diligence involves evaluating the commercial position of the business, including the market, valuation, performance, feasibility, profitability and growth potential.

    Operational due diligence considers the operational aspects of the business, such as personnel, supply chain, logistics, quality, systems, technology and efficiency.

    It is prudent to engage the relevant experts to assist with conducting commercial and operational due diligence of the business, and appointing an industry expert can be critical in certain industries.
  1. Financial

    It is important to obtain financial and tax advice in respect of any business acquisition. An accountant or financial advisor should be engaged as soon as practicable during the due diligence period.

    The process involves examining the assets and financial records of the business to ensure that it is financially sound and that the purchase price is commensurate with the financial position of the business.

    Financial due diligence further entails considering financial responsibilities, such as employee entitlements, and reviewing the tax returns and business activity statements of the business to ensure compliance with its statutory obligations.
  1. Legal

    Legal due diligence involves obtaining and examining information, without limitation, regarding:

    1. the corporate structure of the business;
    2. corporate governance mechanisms;
    3. any applicable licenses, permits or approvals;
    4. insurance policies and insurance claims;
    5. any legal proceedings to which the business is a party;
    6. any purported legal proceedings against the business or to be commenced by the business;
    7. breaches of any agreements to which the business is a party;
    8. any claims, debt, orders for compensation or damages brought against the business or brought by the business against another party; and
    9. intellectual property rights (including copyrights and trade marks).

    The business would have entered into various legal agreements, such as a lease, franchise agreement, service agreements, supply agreements, employment agreements and other such contracts. Legal due diligence involves reviewing all relevant agreements to:

    1. understand the legal rights and obligations under those agreements;
    2. ensure there are no breaches or purported breaches of such agreements; and
    3. determine whether such agreements are transferrable and, if so, the requirements to transfer or assign those agreements.

    It is prudent that a purchaser engages a lawyer to assist with:

    1. advising on the legal risks associated with the business;
    2. reviewing the proposed contract for sale for the purchase of the business;
    3. reviewing and advising on any relevant agreements; and
    4. attending to the necessary enquiries, including ASIC and PPSR searches.

Key Takeaway

While due diligence may be a time consuming and expensive exercise, it is an essential step when acquiring a business as it allows the purchaser to:

  1. assess the risks associated with the business;
  2. obtain crucial advice regarding the legal, financial, commercial, and operational aspects of the business; and
  3. make an informed decision before entering into an unconditional contract.

A successful due diligence investigation can ultimately save time and money and assist with reducing the stress of having to bear the consequences of any undisclosed risks of the target business.

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