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Business Blog: Due Diligence - From a Buyer's Perspective

By Brian D. Merklin on August 12, 2019

From a buyer’s perspective, what is due diligence in a Mergers and Acquisitions (M&A) deal?

Due diligence is a process by which the buyer is able to investigate and analyze the assets, liabilities, records, financials, and customers of a business to ensure that what is being acquired aligns with the buyer’s expectations. This is important for many reasons, including protecting the buyer from misrepresentations and omissions of fact regarding the purchased assets. The objective is not only to ensure that each of the assets is sufficient for the purpose for which it is being bought but also to limit risk for the buyer. It is critical for buyers to avoid unknown risks and liabilities, and to understand what is being purchased. Performing thorough due diligence is an important process in ensuring that the buyer understands the purchased assets, as well as the associated risks.

What kind of due diligence needs to be done?

A. Due diligence when real property is involved

Every transaction involves a different depth of due diligence based on the sophistication of the deal, as well as the type of assets being purchased. Typically, in a deal involving the purchase of real property there are several steps that a buyer should take to ensure that the property is not only free and clear of all judgments or liens, but also to determine whether the property is suitable for its intended use. Regarding judgments, it is important for a buyer to complete a lien, judgment, UCC, litigation, and mortgage search in the county and state in which the property is located. This will reveal any issues involved with encumbrances attached to the property. Title work provided by a title agency is also important to help uncover any issues with the title of the property. Careful review of these issues is important in determining whether a piece of property can be validly transferred, free of any encumbrances.

Additionally, if real estate is involved in the M&A deal, it may be important to conduct some environmental evaluations. This can be a vital step in reducing the risk that the buyer may be purchasing property that could subject the buyer to liability based on existing environmental conditions on the property. Problems can be identified through the use of a phase I environmental assessment by third party contractors. Additionally, if any recognized environmental conditions are identified, a phase II can be conducted to assess the issues and provide a remediation plan.

B. Due Diligence for the purchase of tangible personal property

One of the most important steps in conducting thorough due diligence in regards to tangible personal property is a UCC search. This type of search will help to determine whether there are any security interests which encumber any property. Additionally, checking the title certificates to any titled assets will help to determine whether the seller has unencumbered title to the purchased assets. A physical inspection of the property can also assist a buyer during the Due Diligence Period. This is important in determining the condition and sufficiency of the property, as well as ensuring that the amount of the property and its condition matches with the buyer’s expectations. Buyers should ensure that the assets they are buying are useable for the purpose for which they are purchasing them.

C. Due diligence for the purchase of intangible assets

Due diligence is also a critical step in certifying that there are no unknown issues regarding the intangible assets and that the assets are worth the purchase price. One of the major types of intangible assets is intellectual property, (IP) including trademarks and copyrights. Ensuring that the seller actually has rights to the IP is important to confirm that they are able to validly transfer ownership. This can be achieved through a search of the United States Patent and Trademark state offices and other online databases. Additionally, if the seller’s IP are subject to licenses, it is important to make sure that the seller is in compliance with the terms and conditions of the licenses.

D. Other areas in which due diligence is important

There are numerous other aspects of purchasing a business which require thorough due diligence. Taxes, and the potential successor liability which can arise from the nonpayment or non-filing of taxes, are an important aspect of purchasing a business. Ensuring that the taxes of the predecessor were timely filed and paid is critical in limiting the risk of successor liability. Taxes include employee withholding taxes, sales and use tax, workers compensation, and other taxes. Payment of taxes is crucial, and any failure to file or non-payment of these taxes may result in successor liability, as well as the personal liability of the buyer.

It is also important to understand and evaluate the employee benefits associated with the purchase of a business. Types of employee benefits that need to be evaluated include paid time off, retirement account matching, pension plans, and health insurance. Determining the benefits in place and their legal requirements limits liability and also ensures a smooth transition for employees. Workers’ compensation claims also need to be part of any due diligence evaluation made during any uncovered periods.

E. Technology

Technology plays an important role in how many businesses operate. Consequently, it is crucial that a potential buyer understands what type of technology is employed in the purchased business, as well as how it operates. Understanding this type of information, as well as determining whether the technology currently employed is up-to-date and functioning properly, will reduce the risk that the buyer may be required to spend time, energy, and money upgrading or fixing the technology in use. Software and licenses need to be transferred and any technology used to manage assets, such as inventory or accounting software, need to be up-to-date, and reflect accurate data.

Conclusion

Due diligence is one of the most important processes in evaluating any purchase of a business. Understanding the many potential risks and liabilities, as well as the condition and status of all of the assets of the target business is imperative when deciding whether to purchase a business. 

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