How To Be Diligent With Your Diligence
Tuesday, April 15, 2003
by
Catherine Feechan
In the past, acquisition due diligence consisted of asking your accountant to have a quick look over the books and your lawyer to check the legal agreements for any “nasties” lurking in the background. Assuming neither of them said there was anything to be unduly concerned about, you could go ahead and do the deal.
How times have changed! Now diligence takes many different forms - commercial, legal, financial, environmental, IT, pensions and risk assessment to name but a few – and it has become a complicated process that needs careful management in order to ensure that clients get an effective, cost efficient service that delivers the information they require.
Managing the due diligence process is easy to get wrong, resulting in unhappy clients and increased risk of litigation against professionals. Both these concerns can be addressed by managing the process effectively based on the following 10 step plan:
1. What does the client want? It is absolutely vital at the outset to obtain proper instructions from your client. You need to understand clearly the proposed deal, what your client already knows about the target company and what they want to know. Getting an understanding of what the clients view as key risk areas at the outset will help to tailor the diligence process to address these issues in the most cost effective way. It is also worth bearing in mind at this point how your client intends to fund any proposed transaction. There may be areas which are not of concern to your client, but will concern funders who may require additional diligence.
2. Costs and Timescale. The next key question is how much they want to spend and what the proposed timescale for completion is. Inevitably, both these factors will be discussed at length and it is important that the client is given realistic expectations as to what can be achieved within the budget and timescales they agree.
3. Co-ordination. It is advisable that one professional adviser, usually the solicitors or accountants, assume the responsibility for co-ordinating the due diligence process. They will be able to assist with selection of appropriate professional advisers in all diligence areas and should be responsible for management of this team. This will save a very busy client from having to shoulder this responsibility, which they may simply not have time for.
4. Planning. The chosen co-ordinator of the diligence process needs, having discussed matters with the client, to plan carefully the types of due diligence required and the order in which that diligence will be carried out. The exercise should be tailored to the individual transaction, taking account of the key risk areas and each team of professionals should be well prepared and briefed.
5. Vendor Liaison. In order to preserve relations with the Vendor, it is important to ensure that they are aware of and able to provide input to the proposed timetable. There is no point, for example, in scheduling accounting and legal due diligence at the same time if the Vendors do not have the resources to cope with that. Obtaining Vendor cooperation before the process starts should allow an effective use of time and asking the Vendors to appoint one person to be in charge of the diligence process is also useful. This ensures that should any problems arise during the conduct of the exercise, these can be quickly sorted out at a senior level.
6. Letters of Engagement. Each professional carrying out any part of the diligence process should enter into a letter of engagement. These can range from the very formal documents prepared by Accountants to much shorter and more informal letters outlining the scope of work to be carried out and the fees to be paid. By reviewing the letters of engagement, the Co-ordinator should be able to ensure that all key areas are covered by only one professional team and thus minimise overlap of professional time and costs.
7. Reporting Lines. It should be made clear to all professionals on the team how the client is to receive information. It may be useful for all reports from professionals be made to the due diligence co-ordinator with that person taking on the direct client liaison role.
8. Reporting Key Issues. All professionals should be aware of key issues which are going to impact on deal structure, timing and price. Where these arise these should be reported verbally as soon as possible to allow the client to assess their impact on the transaction. For example, diligence may reveal that a client acquiring a multi-national business requires to obtain Governmental consents in certain countries – in that case completion may require to be delayed. It may be discovered that key contracts contain change of control provisions which allow the contract to be terminated should the target company be sold - again, this is something that would require to be brought immediately to the attention of the client, who may not wish to proceed without an assurance that the vital contract will not be terminated.
9. Verbal and Written Reporting. It should always be remembered that the people using the diligence reports prepared by professionals are not experts in finance, law etc. These reports should be written in clear layman’s English in order to be easily understood and the key issues should be summarised at the beginning of the report in order to allow the reader to quickly assess any important issues. It may be worthwhile at the conclusion of the diligence process to make a presentation to the clients so that each diligence provider can present their findings and discuss any questions directly with the clients. This can be an effective way of allowing them to assimilate a lot of information over a short period – it is however important to emphasise to clients that they must still read the due diligence report. Paying for a diligence exercise but failing to review the results is not cost effective!
10. Use of Information. Professionals should always remember the purpose of the due diligence exercise – to ensure that:
- the vendor is selling assets to which it has good title;
- to assess the value of those assets to the purchasing client;
- to discover how to transfer those assets; and
- to discover how best to integrate the target into the purchaser’s business.
A well executed due diligence exercise can save the client money by allowing them to negotiate price reductions, minimise risk by seeking appropriate contractual protection and to properly plan post acquisition integration. Therefore, commissioning an effective due diligence exercise is money well spent.
Conversely, a poorly executed due diligence exercise can result in overpayment by the client, failure to obtain proper warranties and indemnities and, critically, litigation against professionals for failing to alert the client to all relevant risks.
Getting clients to understand the value of an effective due diligence exercise should not be difficult – saving money and minimising risk is not hard to sell. Too many diligence exercises are carried out following a standard formula and fail to address the needs of particular clients resulting in client dissatisfaction and risk of PI claims.
They key to success is to be diligent with your diligence!
The information contained in this article is given for general information only and does not constitute legal advice on any specific matter.