Due diligence in an acquisition: why the investigation sets the price
A thorough due diligence is more than a box-ticking exercise. It shapes the price, the warranties and the room for negotiation.
Written by
When a business is acquired, due diligence is sometimes seen as a formality: a list of questions, a data room and a report that nobody reads from cover to cover. That is a missed opportunity. A properly conducted investigation largely determines what you pay and what protection you obtain in the purchase agreement.
What does due diligence involve?
In a due diligence exercise, the buyer investigates the business it intends to acquire. The legal review covers, among other things, the corporate structure, key contracts, employees, real estate, intellectual property, permits and pending or threatened disputes. A financial and tax review maps out the figures and the tax position. These reviews belong together: a contract with unfavourable termination provisions is a legal risk, but also a financial one.
From finding to purchase price
Every relevant finding has to land somewhere. Sometimes a risk justifies a lower price. Sometimes it is better to cover the risk with a specific indemnity, under which the seller compensates the buyer if the risk materialises. And sometimes a finding is a reason to include a condition precedent to completion, for instance that a contract is amended first or a permit is obtained.
Warranties and the role of disclosure
In the purchase agreement, the seller gives warranties about the business. Anything the seller disclosed during the investigation can often be carved out of those warranties. What was in the data room is then deemed to be known to the buyer. A superficial investigation can therefore leave the buyer with less protection than it thinks. Conversely, the seller has an interest in careful and complete disclosure.
Price mechanism
The way the price is determined is also linked to the investigation. Under a locked box mechanism, the price is fixed on the basis of a balance sheet at an earlier date and any leakage of value after that date is excluded. With completion accounts, the price is adjusted to the figures at the completion date. Which method suits depends on the business and on the outcome of the investigation.
For the seller: vendor due diligence
Sellers sometimes commission an investigation of their own in advance. This reveals weak spots before a buyer finds them, making it possible to remedy them or to be prepared for them in the negotiations. It also speeds up the sale process.
Our experience
Our lawyers (advocaten) have guided a large number of acquisitions, acting for both buyers and sellers, in the Netherlands as well as in Germany. We work closely with the financial and tax advisers, so that the findings of all reviews come together in one clear negotiating position.
This article contains general information and does not constitute legal advice. Legislation and case law may change, and the outcome always depends on the circumstances of your situation. For advice on your matter, please get in touch with us.
