Due Diligence

1. What is a Due Diligence?

A Due Diligence of a company is a study or audit carried out by external consultants who analyse the details of the various areas of the commercial company to check that it complies with the applicable legislation and that there are no legal risks.

Due diligence is generally performed in several situations:

• When you want to buy a company.
• When you go to an investment round.
• When there is a change in the company’s administrative body.

The due diligence process has several phases:

• Delivery by the consultant who carries out the study of a list with the documents and information that he needs to carry it out.
• Verification by the company of the information it has and delivery of what is requested. If you do not have a document, you must ask or prepare it or explain why you do not have it. If the document does not exist, it may appear as a contingency in the report prepared by the consultants.
• Signature of a confidentiality document by the consultants.
• Study of the documentation and preparation of the report. The duration of this procedure varies greatly depending on the volume of the operation and the information provided. On average, it is usually between three and four weeks.
• Preparation of a report that will contain the study of each document and all the contingencies that have been detected and that may affect the sale operation.
• Presentation of the report. Finally, the consultant who has prepared the report will present it to his client, explaining in detail each part and, above all, the obstacles or problems that have been encountered.

The Due Diligence report is essential since it may suppose that the sale is not carried out, that additional guarantees are requested from the seller or that a period is established for the contingencies to be solved.

2. Tax Due Diligence

The goal of a Tax Due Diligence is to detect potential tax and labour risks to set the Reps & Warranties of the transaction.

3. Labour Due Diligence

The labour aspects of the company being purchased must also be studied to detect contingencies. In the Labour Due Diligence, elements such as:

• Work contracts signed with company employees. The objective is to see, for example, if there is abuse in temporary hiring, if there are special agreements, shields of a worker and verify if the applicable regulations are met.
• Remuneration. It is also essential to see what the company’s remuneration policy is like: fixed, variable, or in-kind remuneration for employees. It will be analysed if the conditions of the applicable collective agreement are met.
• Working time. The Labour Due Diligence will be analysed if the working calendar, the working day, and the working hours are met. It will also be seen if overtime is adequately paid.
• Social Security. Social insurance, work accidents, variable remuneration contributions, etc., will be reviewed.
• Pending litigation. If there is any pending litigation, it will also be reviewed, as well as if there is a pending labour inspection.
• Prevention of occupational hazards. The company will be analysed to see if the occupational risk prevention regulations are met.

4. Accounting Due Diligence

The accounting Due Diligence is carried out jointly with the financial one, and the accounting statements and the possible risks that may arise are analysed.

The data used for the Accounting Due Diligence and the financial one must be accurate and reliable so that the final report is correct.

5. Financial Due Diligence

The Financial Due Diligence analyses the situation of the company. It aims to understand how the business works, its evolution over time, and its main metrics, in addition to reviewing the accounting aspects and supervisory processes systems.

This analysis is linked to other aspects such as accounting, legal or tax.

In the financial Due Diligence, the following aspects are analysed:

• Evolution of sales and other items (operating expenses, personnel expenses, etc.).
• Calculation of EBITDA to know the profitability of the company.
• Analysis of assets and liabilities. It will be seen:
  • If there are any undervalued or overvalued assets.
  • The coherence of the investments made and the need for working capital.
  • The net debt according to the period under analysis.
• Study of house flows. The ability of society to generate cash and the level of financing it needs to maintain itself will be studied.
• Study of financial projections. They will be analysed to check if they are realistic.

6. Legal Due Diligence

In the Legal Due Diligence, aspects that may generate legal liability and that could modify the terms of the transaction are collated. Some of the elements that are analysed are:

• Patents and trademarks.
• Environmental aspects.
• Commercial aspects (articles of incorporation, partner agreements, statutes, powers of attorney, capital applications, ownership of shares or participations, etc.).
• Intellectual property.
• Conditions of the lease contracts.
• Contracts with suppliers and customers.
• Litigation for and against to.
• Guarantees provided (bank guarantees, bonds, etc.).
• Agency or distribution contracts.
• Data Protection.

7. Business Valuation

In the sale of a company, there are two essential elements: Due Diligence, with all the aspects that we have seen, and the company’s valuation.

The value of a business can be determined in many ways:

• In a static way. In this case, only the elements of the balance sheet and the income statement are considered.
• Dynamically. In this case, other elements are considered that can generate value in different areas of the company and increase the price of the company.

To value a company, it is essential to consider three elements:

• Price. It is the market value, what a buyer is willing to pay.
• Cost. This is what it costs to keep the business running, both from an operating cost and a receivable debt point of view.
• Value. It is a more subjective element because it considers tangible and intangible aspects that can give future profitability to the company.

8. Buying and Selling Shares and Companies

The preparation of Due Diligence, as we have seen, is one of the phases of a company buying and selling process. The complete process of buying and selling companies follows the following stages from a buyer’s point of view:

• Study of various options. The buyer analyses different companies available in the market if he wants to buy a company or a share and how much money he wants to invest.
• Preparation of the sales notebook. With the sales notebook, the companies being sold provide the company’s essential information to the buyer.
• Valuation of the company. It is carried out based on the criteria that we have seen in the previous section.
• Negotiation and Due Diligence. In this phase, the parties initiate contacts to establish the terms of the future agreement and the Due Diligence report of the company for sale is carried out.
• Buy offer. As part of the negotiation process, the parties can make offers and counteroffers.
• Sale and deed closing. Finally, the sale will be closed, and the sale contract will be made before a Notary Public.

9. Conclusions

As you have seen, Due Diligence is an essential process for the sale of companies and provides legal security to the operation. It must be carried out by expert consultants who know how to see the risks and provide solutions so that the transaction goes ahead and closes without prejudice to the buyer.