The meaning of due diligence in the context of purchasing a business
The first major task involved in any proposed purchase is called due diligence. It is the process by which the purchaser examines the ‘target’ (assets collectively, business or company) to determine whether to proceed with negotiations on the purchase, how the transaction would be structured and what the purchaser believes the target is worth. This article will examine the tasks that the purchaser needs to undertake before the share or asset purchase agreement is finalised.
Sign a Non-Disclosure Agreement (‘NDA’)
One document that is ancillary to the share or asset purchase agreement is an NDA, or a Confidentiality Agreement. Before the vendor reveals its records to the purchaser, the vendor will usually expect the purchaser to sign an NDA. As the records are commercially sensitive, the vendor would want an NDA to be signed to deter the purchaser from competing with the vendor if the sale does not proceed. Common terms of an NDA include:
– mutual confidentiality obligations on both parties with respect to all information each receives from the other party;
– a prohibition on either party publicly announcing the transaction; and
– obligations on the return and/or destruction of materials either once the transaction is completed or determined that the transaction will not proceed.
Prepare a Memorandum of Understanding
Another ancillary document that needs to be prepared is the Memorandum of Understanding, also known as a Heads of Agreement. It records the critical elements of the transactions that the parties have agreed in-principle as well as those that remain outstanding. Matters that should be addressed include, but are not limited to:
– Name of the parties;
– Purchase price;
– A non-reliance provision; and
– Composition of the purchase consideration.
Searches and enquiries
The type of searches carried out will vary from business to business. Due diligence generally involves searches of the following:
– Search the Personal Property Security Register to find any security interests over the company, such as charges taken by the vendor’s bank to secure the company’s borrowings. The purchaser needs to make sure that the assets being purchased are not subject to any registered encumbrance.
– Search the company name on ASIC to confirm that the company exists and is not subject to external administration.
– Search records relating to the registration of any relevant trademarks.
– Search NSW Land Registry records to identify the owner of the land, any mortgagees and any inconsistent registered leases.
If the business is a real estate agency, a restaurant or a bar, then the purchaser’s lawyer should review the licence conditions and compliance with those conditions.
The purchaser may request to view a large volume of documents including financial records, legal documents and other business records. Financial records, including sales figures, staff salaries, customer lists and budgets and forecasts, are usually inspected by the purchaser’s chief financial officer or accountant. Legal documents such as contracts and leases are inspected by the purchaser’s solicitors.
The purchaser may also wish to run interviews with employees of the business, attend management presentations and inspect the premises, plant and equipment.
Due diligence is a complex and essential step prior to any purchase of business. Tasks include the signing of an NDA; preparation of a Memorandum of Understanding; and searches and enquiries. Altogether, they can consume a significant amount of purchaser’s resources. Therefore, it is prudent for purchasers to seek legal advice prior to purchasing a business to minimise risk and costs.
Disclaimer: This publication provides general information of an introductory nature and is not intended and should not be relied upon as a substitute for legal or other professional advice. While every care has been taken in the production of this publication, no legal responsibility or liability is accepted, warranted, or implied by the authors or our firm, and any liability is herby expressly disclaimed.