Due Diligence in a Business Acquisition What Gets Reviewed and Why
Due diligence is how a buyer finds out what they are actually buying. Miss something here and you may inherit a significant problem with limited recourse after closing.
What is Due Diligence?
Due diligence is the investigative review a buyer conducts before completing an acquisition examining the target's legal, financial, and operational affairs to verify what is being sold, identify risks and liabilities, and confirm the basis for the purchase price. It typically runs between the signing of a letter of intent and the execution of the definitive purchase agreement.
Legal Due Diligence
Corporate Records
Review the Certificate of Incorporation, Articles, minute book (is it complete and current?), share register (who owns what, are there any transfer restrictions or pre-emptive rights?), and the shareholders agreement (any ROFR or drag-along rights that affect the transaction?).
Material Contracts
Review all significant customer and supplier contracts are there change of control provisions that allow termination if the company is sold? Review commercial leases do they transfer in a share sale or require landlord consent? Loan agreements any change of control covenants that could trigger repayment?
Employment
Review employment agreements for change of control bonuses or enhanced termination provisions. Review contractor arrangements for misclassification risk. Identify any pending or threatened employment claims.
Intellectual Property
Confirm that key IP is held in the corporation, not personally by founders. Review IP assignments from employees and contractors. Verify registered trademarks, patents, and domain names.
Litigation and Regulatory
Identify any pending or threatened litigation, government investigations, or regulatory proceedings. For properties with physical operations, review environmental assessments and OHSA compliance history.
Financial Due Diligence
Review three years of financial statements (audited or reviewed preferred), tax returns and any CRA assessments, accounts receivable aging, inventory condition, and off-balance sheet liabilities. Outstanding tax liabilities that are not disclosed will transfer to the buyer in a share sale.
What Findings Lead To
Due diligence findings can: reduce the purchase price, require specific representations and warranties in the purchase agreement, require the seller to remedy issues before closing, or in serious cases, allow the buyer to walk away from the deal entirely.