Before buying a business, it is recommended that the buyer undertakes due diligence on the target business.  In conducting due diligence, a buyer should aim to know as much about the target business as it does about its own business. 

The following are some key tips to keep in mind when conducting due diligence on a target business:

• Negotiate an exclusivity period with the seller:  An exclusivity period will ensure that the buyer can devote time and resources to undertake due diligence as the only prospective buyer and without being concerned that the seller is, at the same time, trying to solicit other offers for the target business.
• Engage experienced advisers:  A buyer should engage advisers (such as lawyers, accountants and tax advisers) experienced in advising on M&A transactions to assist in conducting (and reporting on) due diligence on a target business.  Advisers experienced in M&A transactions and conducting due diligence will know what issues to focus on (or look out for) during the due diligence process.  
• Agree on the scope of the due diligence:  Before obtaining detailed information on the target business, the buyer and its advisers (legal and financial) should agree on the scope of the due diligence.  The scope of the due diligence review will depend on factors such as the nature of the business, the size and value of the business and the risk appetite of the buyer.  Often, materiality thresholds are adopted to enable the buyer’s due diligence team to focus (and report) only on matters that exceed the thresholds, making the review of the due diligence materials relevant and efficient.
• Obtain detailed information about the target company:  A buyer should request detailed information from the seller about the target business.  To assist with this, the buyer (or its advisers) should provide the seller with a detailed due diligence questionnaire/checklist that requests information (and copies of documents) about the target business. Ideally, the seller will respond to the due diligence questionnaire/checklist while at the same time collating the supporting documents in an online data room.  The materials in the data room should, as far as is possible, be arranged in folders (and sub-folders) that correspond to the structure of the due diligence checklist to make it easy to locate information in the data room and to make it easy to delineate the sections of the data room that each of the buyer’s experts will focus their review on.
• Conduct a detailed and targeted review:  Once the Seller has completed the questionnaire and uploaded documents into the data room, the buyer and its relevant advisers will review the completed questionnaire/checklist and material in the data room.  Typically, a due diligence review is divided into:
• Legal due diligence:  includes a review of the corporate structure and records of the target company, material contracts, results of searches of registered intellectual property, business names, registrations of personal property securities and other securities, and current proceedings, transfer of employees and their entitlements.
• Commercial due diligence:  includes a review of real property/premises, plant and equipment, stock and inventory, systems and processes, employees, customers, products and services, suppliers, assets, insurance, market trends and issues.
• Financial due diligence:  includes a review of financial performance, financial position, maintainable earnings, debtors, creditors, work in progress, salaries and wages, superannuation, finance facilities, guarantees and bonds, pre-payments, tax returns, liabilities, notices, disputes, penalties.
• Tax due diligence:  includes a review of tax returns, liabilities, notices, disputes, penalties, etc and the tax impact of the transaction (as structured) on the buyer; and
• Obtain formal due diligence reports:  Once the buyer’s advisers have completed their review of the due diligence materials, they should report to the buyer in writing on their findings.  Often, advisers may report to the buyer on an “exceptions basis” only (unless the buyer requires otherwise).  This means that the due diligence report would only mention issues identified from the due diligence exercise whose value or impact would be over a certain materiality threshold.  The recommendations will inform the buyer’s decision on what action(s) to take in relation to the material issues identified during due diligence. 
• Allow sufficient time:  The collation of relevant documents and information by the seller, and the review of those materials by the buyer, take time, so allow sufficient time for proper due diligence to be undertaken as part of the transaction timetable.
• Negotiate relevant protections in the transaction documents:  Following completion of the due diligence process (and provided the buyer wishes to proceed with the transaction), the next step is negotiating and entering into definitive transaction documents to formalise the proposed sale and purchase of the target company.  The material issues identified in the due diligence reports and the respective recommendations of the buyer’s advisers will frequently translate into protections sought by the buyer in the relevant transaction documents, which may include the completion of certain remedial actions as conditions precedent to completion; a pre or post-completion undertaking to take a specific action; an indemnity to protect the buyer from specific material risks; or additional warranties addressing specific or general areas of concern for the buyer.

If you have any questions on buying a business, undertaking legal due diligence or would like assistance with conducting legal due diligence on a target business, please do not hesitate to get in touch with one of the Sierra Legal team.