Importance of the Due Diligence Process in Corporate Transactions
What is Due Diligence?
Due diligence is a term used to refer to a process of conducting investigations, searches and inquiries in connection with commercial transactions. In this blog, the term due diligence will be referred to in connection with the acquisition of a target corporation.
The purpose of the due diligence process is to gather information in order to enable the lawyers, accountants, financial advisors and the proposed purchaser to become familiar with the relevant aspects and gain a level of comfort about the target corporation, or not, in order that the target corporation can be purchased, or not, at a negotiated price. The purchaser should always conducts a due diligence review of the vendor and of the target corporation, whose assets or shares are being purchased. The vendor may also conduct due diligence on the proposed purchaser where, for instance, the vendor is taking back debt, whether secured or unsecured, as part of the purchase price or is receiving shares or other securities of the proposed purchaser as part of the purchase price.
Non-Disclosure and Confidentiality Agreement
This agreement prevents the proposed purchaser and vendor from disclosing the existence of the negotiations as well as from disclosing or using the information provided by the purchaser, vendor or the target corporation for any purpose other than evaluating the transaction. We strongly suggest that such an agreement is to be required by the parties, before entering into the due diligence process, in order to maintain confidentiality with respect to information disclosed as part of the due diligence process or negotiation process in the event the transaction is not completed.
Asset purchase vs. Share purchase
In an asset purchase transaction, the proposed purchaser will enter into an agreement with the target corporation to acquire only those assets that it desires to purchase, and to assume only specified liabilities. The rest of the business (typically unwanted contingent and unknown liabilities) remains with the target corporation. In the context of this type of transaction, the proposed purchaser will perform due diligence to provide additional comfort that it has properly identified the assets to be purchased and liabilities to be assumed.
In a share purchase transaction, the proposed purchaser will acquire all of the shares of the target corporation itself and, as a result, acquires all of its assets and liabilities, known and unknown. In this context, it’s typical to perform a more extensive due diligence on the assets and liabilities held by the target corporation, as well as a review of the corporate records of the target corporation in order to confirm, among other, that the proposed purchaser is acquiring all of the shares issued of the target corporation and to also confirm that such shares were properly issued or acquired by the vendor.
You will find below a non-exhaustive list of matters to be covered in the legal due diligence process of either an asset purchase or share purchase transaction:
- a review of contracts to which the target corporation is a party;
- public record searches for registered security on the target corporation’s assets and on the vendor’s assets;
- a review of any litigation to which the target corporation or the vendor is a party;
- a review of all employment related matters on the target corporation’s employees;
- public record searches for registered writs of execution against the target corporation or the vendor;
- public record bankruptcy searches on the target corporation and of the vendor;
- searches with respect to tax and HST with al taxes relevant authority on the target corporation and the vendor; and
- a review of intellectual property owned or used by the target corporation.
It’s important to notice that legal due diligence is in addition to a review of the financial and tax position, marketing and operations of the target corporation, which is generally conducted by the proposed purchaser or its financial advisers. Finally, depending on the nature of the business of the target corporation that’s being acquired, often additional due diligence (for example, environmental) may also be relevant.
As you can see, there are certainly a number of issues to consider in the due diligence process. A few have been discussed here, but rest assured there are indeed many more factors to consider.
Should you have any further questions about the due diligence process, I would be glad to provide you with further information.