Explaining due diligence in M&A
Due diligence forms an essential part of a Corporate/M&A transaction. Buyers look at its outcome when deciding to pursue a transaction and - if they do - how. Sellers can benefit from a vendor due diligence investigation. Due diligence impacts the deal as it shapes the parties’ legal positions and the structuring of the transaction.
It helps sellers and buyers to fulfill their respective obligations to investigate and disclose. On top of that buyers gain in-depth knowledge of the target’s business and simultaneously benefit from the opportunity to prepare for post-merger integration. The data room plays an important role in the game.
Let us tell you why!
Some legal observations
In M&A a seller is required to disclose relevant information regarding the target to the prospective buyer. The seller must give the buyer the possibility to perform due diligence. To the extent relevant, documents and other information are provided and questions are answered by the seller.
The seller is required to disclose relevant information
He should also proactively inform the buyer of any characteristics and potential risks of relevance to the buyer. Information often is confidential and typically disclosed in a secured environment such as a virtual data room.
Reliance on only the seller’s disclosures may not be sufficient for a prospective buyer to satisfy his own obligation to investigate the (business of the) target.
The buyer is under the obligation to investigate
Some information provided by the seller requires that the buyer investigates more thoroughly, for instance by asking those questions important to base his purchase decision on.
What to do with due diligence findings
Due diligence findings often have a direct impact on the overall transaction structure and underlying agreements. Identified risks will be allocated between the seller and the buyer by including warranties, indemnities and disclosures in the sale and purchase agreement. In addition, commercial terms (such as purchase price and transaction scope) may need adjustment and mitigants can be put in place.
Identified risks are allocated between seller and buyer
Warranties purport to give the buyer a remedy in case unknown historical facts come to light. A well-known example is “The company has been duly incorporated and validly exists under the laws of its jurisdiction”.
Indemnities are used to place the foreseeable risk of known or probable facts with the seller. An example is “The seller indemnifies and holds harmless the buyer for any damages resulting from the litigation matters”.
Parties may agree that facts known to the buyer at the time of the transaction come for his risk. Those facts will be excluded from coverage under the warranties. Disclosure of relevant facts and circumstances via the data room is most common nowadays.
Well-positioned through due diligence
Addressing due diligence findings in transaction documents often leads to negotiations between the parties. An investigation is valuable if it makes the relevant risks attached to the target clearly visible for the prospective buyer and, ultimately, the seller. The more visibility parties have, the better they can negotiate on risk allocation. We all know, efficient negotiations lead to a higher chance of success for the deal.
Preparation is another factor for success. A ‘sell-side’ or ‘vendor’ due diligence allows a seller to identify and clean up issues that might distract the attention of a buyer later in the sales process. It often functions as a kick-start of the buyer’s due diligence.
Specialists supporting due diligence and the deal process are therefore worth investing in for any party involved in an M&A transaction.
Due diligence facilitates negotiations between parties
The data room typically sits where the seller’s obligation to disclose and the purchaser’s obligation to investigate meet. A well-structured data room adds a lot of value to the due diligence process (and thus the overall transaction). A data room preferably comes with a Q&A functionality tracking all questions asked and answers given, thereby facilitating the parties in meeting their aforementioned obligations.
The data room and information stored therein not only guide parties through the M&A deal, they also play an important role in post-merger integrations. Parties often use the information in the data room as a structured starting point for their integration talks in various operational work streams.
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