The importance of due diligence in business transfer operations

It appears, from recurrent jurisprudence, that during a business acquisition process, the burden of risk related to the object sold is on the buyer if he would have knowledge of them if he had shown due diligence. Due Diligence is required of any buyer and entails consulting documents in buyer’s possession or by performing simple acts of management.

Therefore, failure to conduct a due diligence when buying a business can qualified as gross negligence on the part of the buyer.

It is important to keep in mind that due diligence, normally used in the scope of business acquisitions, refers to the information search process led by the potential buyer on the business that he plans to acquire.  Such investigation focuses on several aspects of the business such as its scope of activity, its possibilities and future prospects, its assets and liabilities, etc.

Thus, the main purpose of the due diligence is to gather the information needed to objectively estimate and set the final price of the business acquisition operation, the transaction structure or the warranties to demand. If information emerges that could pose risks to the economic viability of the transaction, the buyer may reverse his decision.

Within this process of due diligence, we can identify two types of analysis:

The economic and financial analysis

It is to study the financial situation and to evaluate the business’s tangible and intangible assets (buildings, trademarks, market listing score, etc.). Through this analysis, the potential buyer will not only get a description of the business, the sector in which it operates and its strategies, but also information about the business’s accounting systems, internal control, financial situation, organization and human resources as well as environmental factors among others.

Within these analyses, we will detail two of them because of their importance and their relevance during the process of business acquisition:

  • Financial due diligence: to evaluate the financial situation of the business by contextualizing the information in the industry in which it operates. The goal is to study several of its aspects in order to compare the business’s financial ratios with the average in its industry and thus be able to appreciate the company’s operations as well as its market position.
  • Trade due diligence: this allows the buyer to analyse market competition, know the trade dynamics of the industry and the market volume in which the business operates as well as its strategic lines.

The legal analysis

Includes the review and study of the contracts, social issues and potential litigation of the business. Such analysis also includes the study of labour and tax issues:

  • Legal due diligence: evaluate the structure of the company (articles of incorporation, bylaws, societal modifications etc.), the contractual (employees, departments, delegations, etc.) and administrative (everything that relates to licenses and permits) situation. The patents, trademarks and trade names of the business should also be analysed. Finally, the potential buyer should also inform himself about the business’s past, current and future litigations.
  • Tax due diligence: conduct a review of the main taxes charged to the company (corporate tax, value added-tax, withholdings on income tax, local taxes etc.). This also permits the buyer to conduct a preliminary study of the fiscal sustainability of the projected transaction, to estimate the impact of tax expenses on the financial plans, to discover tax assets and liabilities as well as determine the warranties for eventual tax risks, among others.

Lastly, it is important that the process of due diligence is conducted by industry experts, who understand the business of the company and who will, therefore, know where to investigate to ensure that the company is as represented by the seller and that there is no hidden data.

Inés Ducom & Nicolás Melchior

More articles about due dilligence:

Concept and purposes of the due diligence in Spain

Terms and phases of the due diligence as part of a business transfer

This article is not considered as legal advice

Nicolás Melchior

A Law graduate from the Universidad Carlo III de Madrid, Nicolás Melchior specialises in corporate Law, commercial contracts and electronic commerce. Working languages: Spanish, German, English and French. For any further enquiries please Contact us