“Step three! It’s just you and me.”
- Jordan Knight, NKOTB
Let’s say your company is growing to the point where you are considering acquiring a competitor or expanding operations to a new region. First and foremost, I’d like to congratulate you on this huge success! And to ensure it remains a success, please be proactive and conduct adequate due diligence prior to closing these transactions.
So what exactly is due diligence? Simply put, it’s an in-depth review, analysis and evaluation of the target business or real estate deal to make sure there are no red flags that could come back to bite you. In other words, it’s like looking under the hood of the car to make sure you’re not buying a lemon (or worse, something that could blow up on the road).
Make a List, Check it Twice
When starting the due diligence process, it is wise to start with a checklist of items to request from the other side. For example, in the event you are merging with or acquiring another business, your initial list should generally include some form of the following subjects:
There will be many subparts to each of the above subjects, with specific documents and follow-up items requested depending on the type and complexity of the transaction.
As responsive information and documents start rolling in, you can decide whether you have enough information to satisfy concerns related to a particular subject . . . or you can request supplemental information and documents and start chasing rabbits down holes in the event potential red flags emerge.
This Could Happen to You!
The due diligence process should not be taken lightly, as failure to uncover and address landmines within your target can be problematic. Consider the following potential scenarios involving your prospective acquisition target:
It has a shareholder who owns a significant percentage of the company, but is conspicuously absent in company minutes, consents and resolutions involving key decisions.
It has operations in several states, but has failed to appropriately register to do business in half of them.
It has recently received a demand letter from a lawyer with regard to a potential class action involving a product defect.
It has received several letters from local and state environmental agencies with regard to overflow of hazardous waste into a nearby river.
It has a significant union presence, and the local union has filed several recent unfair labor practice charges against the company.
It sells products primarily through direct-to-consumer channels but has not implemented appropriate cybersecurity measures, including procuring cyber insurance.
Its land and equipment are largely tied up by third-party lenders, with additional judgment liens filed in the local recorder’s office.
It has a long-standing relationship with an overseas factory that is notorious for harsh employee conditions.
These are just a small number of issues that could be uncovered during the due diligence process, but you’ll likely want to learn more about them before deciding whether to proceed with closing. Having a robust checklist up front, and then following up with additional requests based on findings can ensure no stones are left unturned.
Seasoned Preventive Lawyers are skilled in navigating the due diligence process. In the event potential red flags are uncovered, Preventive Lawyers can help you understand and assess the risk of exposure and then discuss legal and business strategies to minimize this exposure, including whether or not to ultimately proceed with closing.
Open Your Eyes, Look Within
Due diligence is not only necessary in business mergers, acquisitions or real estate settings, but it can also provide the framework to maintaining ongoing business health. Consider the preventive medicine analogy, where your business undergoes an annual physical to assess health and treat areas of potential “disease.” The physician will perform a “review of systems,” including assessing cardiovascular, pulmonary, neurological, gastrointestinal and musculoskeletal systems, among many other things (cue latex gloves!).
Conducting regular business self-exams utilizing an abridged diligence methodology—or a “review of business systems”—can identify current business health as well as targeted opportunities for improvement before potential exposures start to multiply. For example, a business physical might include:
Review of existing business entities to ensure alignment with tax strategies and opportunities, as well as mitigation of legal and business risks;
Review of business formalities conducted during the year to ensure legal compliance as well as accurate and appropriate business story-telling through minutes, consents and resolutions;
Review of existing and prospective geographical presence to ensure appropriate state-based registrations;
Review of existing and prospective license, permit and regulatory registration requirements to ensure ongoing compliance;
Review of contract practices to ensure proactive negotiation and development practices are being followed, and that business counterparts are compliant with quality and safety standards, insurance levels or other contractual requirements;
Review of business continuity practices to ensure there is not over-reliance on a key supplier or vendor that could result in a business interruption;
Review of legal, regulatory and contractual compliance programs to ensure appropriate training and documentation is taking place;
Review of insurance program to ensure risk transfer practices align with existing enterprise-wide exposures, and that vague or ambiguous language is addressed and clarified before claims arise;
Review of potential claims against third-parties, as well as claims by third-parties against the company that could be tendered to an insurance carrier; and
Review of existing claims and lawsuits to ensure litigation strategies are business-forward.
An experienced Preventive Lawyer can serve as the “internist” to perform this physical, evaluate the overall health of your business, and then take affirmative steps to treat symptoms or refer to a specialist when indicated.
Long story short, due diligence is a necessary component of significant business transactions. Preventive Lawyers are a valuable resource to peek under the hood of target businesses or real estate to make sure you’re not buying lemons . . . and can further be deployed to look under the hood of your own business to make sure it’s consistently operating at optimal health! As always, we’re here to help.