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Due diligence when purchasing a company

As a test drive and reviewing a vehicle’s paperwork part of the process of purchasing a vehicle, due diligence is required in the course of purchasing a company. This is the terminology for the detailed review by the potential buyer of a company that is up for sale. We will explain to you, which areas of a company must be inspected during an acquisition.

What is due diligence?

Following contact between the buyer and the seller, initial documentation for valuation of the company is prepared in the analysis phase, on the basis of which the buyer decides whether or not he will submit a non-binding purchase offer (letter of intent). Due diligence is then conducted – the detailed review of a company being sold by the potential buyer. It determines if sales negotiations will be continued and has a major impact on the details, such as price and any other terms of the sale.

The scope of due diligence varies depending on the type and size of the company. In principle, however, we can say that the larger a company is, the more areas must be scrutinised, which is why involving experts, such as fiduciaries, tax experts or attorneys is highly recommended. The total scope of due diligence is divided into the legal, financial, and business due diligence.

Legal due diligence                                                          

In this subsection, legal deficiencies and risks in the company to be acquired are searched for specifically. In addition to ongoing or impending legal disputes, disputes that have been settled, which could have far reaching consequences, are also analysed. The analysed circumstances typically fall in the areas of corporate law, labour law or antitrust law. Because the benefit and risk of the company are transferred to the new buyer upon acquisition, he must be aware of potential risks. As a subsection of legal due diligence, tax due diligence is likewise a substantial aspect, which helps in the process in uncovering tax risks or opportunities (for example, for tax optimisation). Involving an experienced attorney and/or tax expert is highly recommended here due to the required expertise.

Financial due diligence

Financial due diligence is conducted to find out more about the financial conditions of the company to be acquired. If the company to be acquired involves a small or medium-sized business, which is not normally listed on the stock exchange and thus has no clear price, the results of financial due diligence are also particularly influential for purchase price negotiations. In addition to the seller, the financing bank also has a great interest in a diligent examination because for them the knowledge about financial opportunities and risks are crucial for granting the loan. For this reason, the bank should also be involved – at least in the question regarding what key figures they need with respect to financial due diligence.

The financial conditions of the last three to five fiscal years of the company are analysed. In light of the asset investment, revenue generating assets, and financial investments, as well as current corporate planning, a prognosis regarding future revenues is developed. In particular, the financial and debt situation, expenditure and earnings, cash flow and solvency is audited and forecast. Involving an experienced auditor is recommended for this.

Business due diligence

Business due diligence is conducted to be able to better assess the company value, thus facilitating contract negotiations for the purchase of a company. The company to be acquired and its positioning on the market is thoroughly scrutinised in the process. A market analysis is recommended here – product design and pricing policy, customer and supplier relations, technologies, the competitive situation, as well as the business model require a thorough analysis.

The scope of business due diligence can vary however. While buyers are usually already well aware of the business processes in the course of family-run succession solution or a management buyout, thorough business due diligence is essential when selling to a third party. However, we can generally say that the larger a company is, the more important it is. Information material is most often provided by the seller for this. However, one should not solely rely on this and independently form an image, for the seller will always disclose everything. Involving an expert is recommended in this case as well due to the potentially complex matter.

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