Due diligence is an important and expected part of any merger or acquisition (M&A) transaction. The due diligence process gives the buyer the opportunity to identify any operational or legal risks that may exist with the seller or its business prior to entering into a purchase agreement and closing the transaction. Further, any specific issues (that do not arise to the level of terminating the transaction) identified during due diligence will typically be accounted for in the purchase agreement through the negotiation of terms such as the purchase price, representations and warranties, closing conditions, and post-closing indemnification obligations of the seller.
Typical Scope of M&A Due Diligence
The scope of M&A due diligence and a buyer’s exact requests will vary based on the specific transaction. While not exhaustive, summarized below are some of the general areas almost always covered by a buyer’s due diligence requests:
1. Business Organization. A seller will need to provide its corporate records concerning its formation and good standing, governing documents (e.g., articles or certificate of incorporation or organization, bylaws, operating agreement), share ownership, and capitalization. Other items can include records pertaining to jurisdictions where the seller conducts business or owns or leases real property, and documentation in connection with any equity or debt financings, securities issuances, stock repurchases, or material acquisition or disposition transactions.
2. Accounting/Financial. Requests under this general category will include copies of tax returns for certain periods (typically the prior 2-5 years), financial statements, and documentation pertaining to loan or other debt arrangements. Sellers will also be asked to include any information pertaining to any past or pending tax proceedings or controversies. Other types of reports or statements requested may include budgets, accounts receivable aging reports, an accounts payable list, and other documentation detailing the income, expenses, and liabilities of the business.
3. Operations, Customers, Business Insurance, Etc. A buyer will want to review a seller’s customer, vendor, and supplier agreements, marketing and sales plans and arrangements, other contracts material to the business, as well as commercial liability and property insurance policies and claims. Information regarding real and personal property, including inventory (if applicable), of the seller will be required. Information technology and systems and disaster recovery information is also typical. Other requests will vary depending on the seller’s line of business.
4. Human Resources. Buyers will ask for employee, salary, and bonus information, employment agreements, independent contractor information and agreements, collective bargaining and other labor contracts, health, welfare, and safety practices and policies, and OSHA, EEOC, and other employee-related complaints and proceedings. Also included under this category will be summaries and copies of the Company’s employee benefit plans, including 401(k), medical, dental, disability, and life insurance plans and benefits.
5. Legal and Compliance. This area of due diligence covers all litigation matters, required permits, licenses, and other government and regulatory approvals, intellectual property disclosures and related USPTO filings, environmental compliance, and any other specific legal or regulatory matters applicable to the business.
How COVID-19 May Affect the Due Diligence Process
Due to the uncertainties created by the global pandemic, buyers are likely to approach M&A deals with greater scrutiny than before. As such, buyers may seek detailed information in areas that implicate potential disruptions to the seller’s business, the seller’s financial capability to weather the economic fall-out from COVID-19, and other risks to the target business arising from COVID-19. Specific due diligence areas that a buyer may want to examine more closely include material contracts with customers, vendors, and suppliers (including the seller’s ability to perform under such contracts as well as termination and force majeure provisions), the seller’s debt obligations and ability to repay, business insurance policy coverages and exclusions, compliance with state and local public health orders, compliance with privacy laws that may be implicated (such as if sensitive employee or customer information has been or will be disclosed due to COVID-19), and employee health, safety, and welfare policies and related measures being taken by the seller.
Linden Law Partners has represented sellers and buyers in hundreds of M&A transactions across a variety of industries. We have extensive experience guiding our clients through the ins and outs of the M&A due diligence process. Contact us today for help.