As part of our series of articles on commercial transactions, following an overview of the subject of letters of intent (hereinafter referred to as the (“Letter” or “Letters”) in commercial transactions involving the sale of shares (see https://endlex.ca/letter-of-intent-definition-and-purpose/), we now turn to the subject of due diligence in commercial transactions (the “DD”).
This article is the first of several on the subject, with an emphasis on key points for both sellers and buyers.
1. Definition and concept
The DD is the period which generally follows the signing of the Letter, and during which the buyer has the opportunity, according to the terms agreed in the Letter, to review the target company’s affairs. The seller then provides access to all relevant documents to carry out the DD. At the end of this period, the buyer generally has the right to confirm, at his or her discretion, whether to proceed or not with the business transaction.
For most commercial transactions, buyers generally carry out two types of DD: the accounting DD and the legal DD.
In the accounting DD, the buyer examines, with the help of an accountant who ideally has experience in commercial transactions, the financial and accounting affairs of the target company, notably documents of a financial nature (e.g. financial statements), the company’s tax obligations, cash flow and all other relevant elements which, among other things, help validate the purchase price initially agreed in the Letter.
As part of the legal DD, the buyer, usually with the help of business lawyers or notaries, reviews all the relevant documents of the target company (customer and supplier contracts, employment or service contracts, insurance policies, etc.) to determine all legal elements to be addressed with the seller in the drafting of the business purchase agreement.
Depending on the nature of the target business, or other factors that create commercial value or motivate the buyer to proceed with the transaction, other types of DD may be required. Intellectual property (“IP”) DD may come to mind if the target company’s commercial value of the company consists primarily of a particular IP that the buyer wishes to acquire, in which case the buyer will want to call on an IP lawyer and/or other IP consultants to carry out a DD of the company.
When, for example, acquiring a company with a considerable number of employees in a field where there is a risk of work-related accidents, it may be wise to call in labor lawyers and human resources consultants to assess that aspect of the business.
Similarly, when acquiring a business that, given its nature, collects a significant volume of personal information from customers or other individuals and entities, it may be wise to call on privacy specialists (Act 25, GDPR, etc.) to perform a DD at this level.
You therefore understand that the objectives of a DD include the following :
A. Identify any elements that need to be brought to the attention of the seller as part of the business transaction;
B. Identify any elements that need to be addressed in the business sale agreement, or in any amendments to the letter following the DD;
C. Validate the purchase price initially agreed in the Letter; and
D. Anticipate the issues to be managed by the buyer after the acquisition of the business.
Naturally, we’ll be expanding on this theme in other articles, so stay tuned!
1. Acquisition of shares vs. assets
DD will generally vary according to the nature of the transaction. As mentioned in our article on the differences between a share and asset acquisition (see https://endlex.ca/achat-dactifs-ou-dactions-3-elements-a-considerer/) in a share acquisition, the purchaser essentially becomes liable after the transaction for all the company’s debts and obligations, including lawsuits, tax reassessments or any other legal or fiscal obligations of the company. Consequently, the DD in a share acquisition is often more extensive, as the acquirer must have all the relevant information regarding those obligations.
By comparison, in an asset purchase, since the acquirer generally does not assume the debts and obligations of the target company, DD is usually lighter in this type of transaction.
2. Conclusion
The DD is a crucial stage in a business transaction, for both sellers and buyers. It’s vital to be supported by the right experts, so don’t hesitate to contact us to find out more!
Information provided in this article is intended as general introductory information only. The information provided in this article is not legal advice. It should not be construed as legal advice and should not be relied upon as such. Should you want legal advice regarding the information provided in this article, please contact one of our lawyers.
