The Stages in Buying and Selling a Company, Part 3

The final six and seven parts of the Purchase Agreement for a purchase and sale of a business.

In our last article, The Stages in Buying and Selling a Small Company, Part 2 we covered stage 4, the development of the Purchase Agreement. In The Stages in Buying and Selling a Company, Part 1 we discussed Stages 1 to 3 of the “pre-transaction” steps in the process of selling a business. In this article, In this final article of the series—Stages of Purchasing and Selling a Business– we’re covering a critical component of a business purchase and sales transaction: Stage 5 (Due Diligence), and the transaction’s final stage — Stage 6– The Closing.  

Stage 5: Due Diligence

Due Diligence typically begins when the Buyer sends the Seller a Due Diligence Request Form specifying the documents and information it wants produced for review. That request can be sent early on – even during the drafting of the LOI – or later when the Purchase Agreement is being negotiated and drafted.  

The Due Diligence Period is a critical stage, especially for the Buyer, for it allows it to closely examine the Seller’s records, finances, and operations to determine if they confirm the Buyer’s initial assessment of the business.

I.  Due Diligence can be broken into down into three discrete categories: 

1.  Financial Due Diligence;

2.  Operational Due Diligence; and

3.  Legal Due Diligence 

Financial Due Diligence helps the Buyer assess the Seller’s financial performance, so the Buyer can, for example, compare that performance to objective market metrics.   

Operational Due Diligence can be seen as the Buyer’s chance to “kick the tires” to help it better understand the Seller’s operations. A Buyer will often interview the Seller’s management team to learn the ins-and-outs of the company’s operations to then contemplate how to efficiently operate the company if it is purchased.  

II. Legal Due Diligence can be understood as covering the following three R’s: 

1.  Relationships

2.  Records; and

3.  Risks

III.  Relationships.

An analysis of the Seller’s Relationships is important since the success of every business rests upon the relationships it has with third parties, such as its:

• Vendors or Distributors; 
• Customers;
• Creditors;
• Landlords;
• Manufacturers or Suppliers; and
• Employees.

The analysis can include, for example, ensuring that all key relationships – and the contractual terms of each – are properly documented. 

IV.  Records. 

A Buyer wants to know that a Seller has properly maintained all legal recordsnecessary to run the business, and those records will be reviewed. They include: 

• Basic Corporate Records
  • such as company formation documents, Corporate Minutes, Shareholders Agreements or LLC Operating Agreements, etc. 
• Permits and Licenses; 
• Authorizations and Qualifications; 
• Registrations (Patents, Trademarks, etc.);
• Material Contracts (see below: “Risks”);
• Financial Information
  • such as Financial Statements, Projections, Tax Returns, etc.; and
• Litigation-Related Documents.

V.  Risks.

Finally, the Buyer will need an assessment of the legal risks associated with the Seller’s company. To do so, the Buyer’s attorney would review all Material Contracts the Seller is a party to, such as:

• Loan Agreements;
• Leases;
• Employment Agreements; 
• Shareholder and Operating Agreements;
• Non-Competes and NDAs, etc.

The above contracts are reviewed for potential issues that might arise on or following the transfer of ownership of the company or its assets, such as

• Anti-assignment provisions (which could impede a transfer);
• Extraordinary consents that might be required; or
• Change-of-Control provisions (which might trigger certain Seller or even Buyer obligations). 

Next page- Seller’s Role During Due Diligence