Height is a deal breaker

Identify deal breakers, reduce liability risks

Opportunities and risks of due diligence when buying a company

By Julia Blaue, Hanover | Dipl.-Volkswirt Joachim Rudo, Hanover | Dr. iur. Nikolas von Wrangell, Hanover

"Bayer's Diligence Failure In Merck Deal Haunts Its Monsanto Purchase" headlined the Wall Street Journal on September 21, 2016 - just one of many headlines on the liability of supervisory boards, managing directors and board members who suddenly find themselves exposed to claims for damages from their shareholders because they were in advance or in the course of a transaction process did not show the “necessary care” when examining the target object.

Due diligence, the "required care", is an indispensable part of a company purchase today. It means the precise examination of the purchase object in advance or in the course of a transaction, which the buyer in the Anglo-Saxon region is even fundamentally obliged to (caveat emptor). For good reasons, due diligence, often referred to as "Due Diligence" or "DD" for short, has now also become established with us.

backgrounds

Every purchase is preceded by some more or less superficial examination of the object of purchase. This also applies to company acquisitions, although in practice there is a very wide range of effort and thoroughness - it ranges from the simple transfer of shares to co-shareholders or family members who are (supposedly) very familiar with the company to be sold, to comprehensive weeks Due diligence by external auditors, corporate and legal advisers in complex international transactions with numerous parties. A company as an object of purchase is a living entity that cannot simply be returned in its original condition after several months if defects are discovered. Especially from the point of view of the seller, the possibility of a reversal and return of the purchase object must therefore be excluded in the company purchase agreement.

The decision on the scope of inspection as a buyer and disclosure as a seller should be made consciously by every entrepreneur and other parties involved. Either on the basis of our own extensive experience with company acquisitions or through the involvement of experienced consultants at an early stage.

The conclusion of a confidentiality agreement (Non-Disclosure-Agreement - NDA) should be a matter of course prior to disclosing internal company information through due diligence. This is often done in a Letter of Intent (LoI) in which the seller and potential buyer record their previous negotiation positions and results and the planned further course of negotiations in non-binding declarations of intent at an early stage. Insofar as the essential content of the planned deal is already specified, certain “deal breakers” can be identified - and the disclosure of important company information to potential buyers, who are often the most important competitors, can be prevented.

If the acquisition is made without due diligence, the risk assumed is often reflected in a lower purchase price or more extensive guarantees.

Interests of those involved

While the potential buyer has an essential interest in all essential information, the seller fears that the disclosure of negative facts can lead to claims for a reduction in the purchase price and the issue of comprehensive guarantees. On the other hand, the disclosure of facts or risks leads to the fact that the buyer can hardly invoke fraudulent misrepresentation later on or that the company purchase agreement usually stipulates that liability is eliminated if the buyer was aware of defects when the contract was concluded.

Due diligence offers the opportunity to minimize one's own liability risks for the buyer's management level. Because the due diligence is the basis for the decision on "whether" and "how" - purchase price, guarantee catalog, exemption agreements, tax-favorable structuring - of the planned company acquisition. Insofar as an appropriate review was the basis of one's own decision-making or a due diligence report was even known to the buyer's supervisory bodies, this makes it difficult to make subsequent allegations to the buyer's management.

In the case of debt-financed transactions, the results of the due diligence are also part of the decision-making process for the banks involved.

Occasionally, sellers also carry out due diligence themselves, for example when a company is to be sold by way of a bidding process (i.e. taking into account several potential buyers at the same time), before the actual sales talks begin ("vendor due diligence"). Here, the seller has the opportunity to identify his own "weak points" in his company and to eliminate them before the sale. On the other hand, the vendor due diligence reports are usually also made available to prospective buyers, so that all bidders have the same level of information.

Due diligence process

Which areas of the target company could be burdened with significant risks? To answer this question, a list of documents is given to the seller by the interested party. A due diligence refers i. d. Usually on different sub-areas, of which the financial due diligence, the market or commercial due diligence (market analysis, analysis of the business model), the legal due diligence and the tax due diligence are of great importance.

Instead of sending the buyer his sensitive business documents, the seller usually sets up a so-called data room for the information to be provided. This can consist of files and papers or - as is the more common case today - as an electronic data room. The electronic data room restricts access to certain persons and offers the possibility of being able to prove exactly which persons have opened and seen which documents and when. This can be significant if the buyer later wants to assert warranty claims and the issue is whether the buyer was already aware of the underlying circumstances when the contract was concluded.

After inspection, the documents made available are evaluated by the interested party or their consultants, often accompanied by the so-called management interview, in which certain questions can be asked personally (so-called Q&A process).

This then usually results in a due diligence report by the prospective buyer's consultants, the findings of which flow into the contract negotiations together with other so-called "findings".

Conclusion

The required scope of due diligence and the need to seek external expert advice at an early stage increase with the complexity of the transaction and the expected risks. Ultimately, this applies to both the seller and the buyer side and the respective management. Managing directors are allowed to take calculated risks, although the emphasis here is on calculated. From the seller's point of view, missing information can lead to an “uncertainty discount” in the purchase price or even jeopardize the transaction as a whole.

If the planned transaction comes about, careful due diligence ultimately also means that the buyer gets to know the target company better earlier and can then integrate and continue it better - to the advantage not only of the contractual parties, seller and buyer, but also of the target company and theirs Employee.

Legal due diligence

Legal due diligence analyzes existing contracts and legal disputes and uncovered legal risks. I.a. is about the following questions:

  • Which customer and supplier contracts should be taken over, which, if necessary, should be terminated or adjusted before or in the course of the transaction?
  • What terms and risks do the rental and lease agreements contain? Are these transferable or is there a right to sublet? Does a change-of-control clause rule out the continuation of the lease after a company purchase in view of the new shareholder?
  • Which parts of the company are taken over, which employment relationships are transferred to the purchaser according to § 613a BGB, which remain with the seller? Can restructuring in connection with the company acquisition lead to changes in the workforce? Which collective bargaining regulations apply after the company purchase?
  • Which patents, trademarks and copyright usage rights are available, what can and should be adopted from them, where do license agreements have to be adapted or newly concluded?

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