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Why is due diligence important in an acquisition?

On Behalf of | Nov 4, 2022 | Business Law

A smaller competitor decides to retire and approaches you about acquiring their Georgia company. This move would increase your market share and bring in customers in an additional niche. Due diligence will enable you to discover whether this potential investment will take your company to the next level, land you in legal or financial hot water, or worse. You can gain insight by conducting thorough research before closing the deal.

Learning the target’s story

With a signed confidentiality agreement, as a potential buyer, you and your consultants will have unlimited access to the target company’s financial and other vital data. This includes detail on all assets and liabilities, tax matters, contracts, employment matters, litigation, financial projections and historical financial statements.

Solid due diligence uncovers issues that could affect the target company’s performance post-acquisition. A thorough investigation that turns up clean, well-organized data and a healthy business can boost confidence in moving forward with the deal.

Identifying potential contractual or legal issues

Due diligence includes completing a review of all significant risks. Depending on the target’s size and complexity, this process could take several weeks or months. An in-depth review might turn up issues such as poorly compiled or documented financial statements, non-transferrable customer or supplier contracts that are material to the business and key employees that might leave if the sale goes through.

Identifying necessary protective covenants

A lot can happen between when the deal is signed and its closing date. Buyer and seller covenants protect each party to the transaction. At a minimum, seller covenants often include a requirement to operate the business in its ordinary course between the deal’s signing and closing. Additionally, sellers typically must agree not to take on any new debt and use reasonable efforts to satisfy all conditions specified in the closing document. Covenants often also require the seller to use reasonable efforts to obtain consent to the deal from all material third parties, such as key suppliers.

Business acquisitions are stressful and risky deals. Due diligence as a potential buyer provides valuable insight into the target company to ensure they have financial viability and do not expose you to legal and other risks once the deal closes. Identifying legal and other issues during this phase and formulating protective deal covenants are some of the essential tools that can minimize risk in the acquisition.