Whether it’s the sale of your business, an acquisition or a partnership transaction, too many entrepreneurs unfortunately neglect the due diligence stage. To help you understand this step, we can compare it to inspection when buying a house. It’s the process by which we examine, or have examined, the object of our purchase. Are we getting our money’s worth? Which elements are most at risk? The structure of the transaction will have a major influence on the work to be carried out: are we buying the assets or the shares? The due diligence work involved in a share acquisition is more exhaustive, since all the company’s assets and liabilities are acquired, as well as its accounting, tax, legal and operational history. When acquiring assets, however, only the assets are subject to due diligence.
Due diligence allows you to ensure that the transaction you are contemplating will be a good investment for the buyer, and not a nightmare for the seller.
In many cases, the due diligence review will enable certain modifications to be renegotiated and incorporated into the final sales contract, which will bring about a change in the price of the shares or assets based on the elements identified during the due diligence review. A frequent example of such changes is the reduction of the purchase price in line with a significant drop in inventory value when the company’s inventories become obsolete.
Due diligence MUST be an integral part of the offer or intent to purchase, to avoid misunderstandings at closing. A clause must therefore be included to allow the buyer to be satisfied with the due diligence review, and to be able to amend the final sales contract to take into account the elements identified during the due diligence review.
This review will have different facets, depending on the nature and complexity of the business to be acquired. Generally speaking, however, it will focus on the following major stages, which recur time and again: – financial information – taxation – operations – litigation and contracts – employees – legal aspects.
Financial information
An analysis of financial reports relating to the company’s sector of activity will enable us to assess its performance in relation to others. It will be possible to understand the seller’s situation, to restate the data in the context of the transaction we are examining, and consequently to reassure ourselves about future results. It will also be possible to identify actual and contingent assets and liabilities, debts and maintenance conditions, and the obligation to repurchase certain classes of shares. Finally, an analysis of previous years’ financial reports and the accountant’s file will reassure us as to the reliability of internal accounting data, and enable us to explain historical trends in results.
Taxation and consumption taxes
They include income taxes, withholding taxes, consumption taxes and other regulatory requirements of the tax authorities. This step is crucial, first of all, because all these liabilities can amount to 50% or even more of the company’s sales every year. And in many cases, this liability will follow the buyer for the last three (3) or four (4) years prior to acquisition. So, are the statutory reports accurate and timely? Are they reconciled with the accounting records? Do they comply with laws and regulations?
Operations
This part deals with product quality, customer satisfaction, economic dependencies with one or more customers or suppliers, relationships with suppliers, economic dependencies with employees, the general working atmosphere in the company, technological delays that would oblige the buyer to invest after the acquisition, the effects on customers, suppliers and employees following the transaction, possible economies of scale, the level of inventory needed for production, minimum working capital, etc.
Litigation and contracts
Legal action against the company could jeopardize its profitability, or even its very survival. It should be noted that all contractual commitments must be honored following the acquisition of the company. In some cases, the buyer may be interested in licenses or permits issued in the company’s name, so it’s important to ensure that these are maintained after the transaction.
Our employees
In most cases, they represent an asset essential to continuity, while in other cases, strategic buyers will want to reduce the payroll, but what about specific agreements with each individual, a possible collective agreement, pension plans, CSST files, regulatory requirements regarding pay equity, benefits to be maintained according to seniority, etc.?
Legal aspects
We check the existence of the charter, outstanding shares, the validity of the company, title deeds to movable and immovable property, guarantees granted and registered on the company’s assets, recourse registered against the company, existing intellectual property, registered contracts, and so on.
In conclusion, due diligence is nothing more than taking the time to carefully examine what you want to buy, and for the seller to prepare for this crucial step. Once completed, the seller will be relieved of this obligation, and the buyer will be reassured for the rest. With our extensive experience in this type of mandate, we can help you realize your business acquisition project. Don’t hesitate to contact us to find out more about our customer approach.
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This article was written in collaboration with Marc Legaut, CPA, CGA, Associé Amyot Gélinas Conseils inc.
