Due Diligence: Main aspects and best strategies

Due diligence is crucial for any growing business in today’s challenging environment. When done right, DD can help you mitigate risk.

It became a specialized legal term and then a common business term with the US’ Securities Act of 1933, where the process is called "reasonable investigation." One can be legally obligated to conduct it but it is usually a voluntary investigation.

Due diligence is an extensive process that is usually undertaken by an acquiring firm to thoroughly and completely assess the target company’s business, assets, capabilities, and financial performance.

It identifies issues early on, helps you establish the true value or cost of a business transaction and contributes to how the terms of your agreement are drafted. This means you will be able to negotiate the best terms for your firm.

Essentially, being able to understand and evaluate a prospective acquisition is the first step to a successful M&A process.

But you probably already know all this and are now looking for a law firm in Bulgaria to help you with your M&A due diligence. You are at the right place.

Read on for the best strategies concerning DD and why you should let us assist you.

When to conduct due diligence?

Due diligence is often conducted by a private equity firm and in cases of mergers and acquisitions.

DD is most commonly conducted when:

• acquiring a company or purchasing a business;
• entering into a partnership or a joint venture;
• entering into a major contract;
• purchasing real estate;
• adding a vendor;
• performing a compliance check, e.g.: under the Bribery Act.

You should know that buyers have the right to look at the records, assets and operations of a business before they commit to purchasing or entering into a partnership. Having complete knowledge of the target company will guarantee that you will make the best-informed decisions on mergers and acquisitions.

If you are unsure whether or not you need to perform due diligence or how to proceed in your specific case, you can easily contact our law firm in Sofia, Bulgaria and get a piece of professional advice. We can also help companies engaging in a merger, acquisition or investment to conduct an impeccable due diligence process to avoid any risks and complications.

You can also check out our article on things you need to know about M&A deals during COVID-19.

Due diligence: Best strategies

Due diligence is a key risk management tool that is equally valuable for buyers and businesses, helping you make informed decisions and avoid costly surprises.

However, the process can be time-consuming and tedious. Buyers might have to communicate with various parties (lawyers, accountants, brokers) to access different levels of information and records. Then the buyer will have to review the collected information and often make further requests.

Fortunately, nowadays gathering and accessing all that information is easier than ever thanks to the ability to create a due diligence data room online. The due diligence virtual data room securely stores important documents and files, providing a single space for multiple parties to access and request information. It is highly recommendable to use one to make your due diligence process faster and smoother. There are many different data room providers online so take a look and choose the one that best fits your needs.

What’s more, entrusting our law firm with the whole cumbersome task will easily solve all of your problems and ease your mind. We will efficiently gather all necessary information, coordinate all aspects and carefully examine the legal documents to ensure the deal you are about to sign is 100% legit and beneficial for you and your business.

How to perform due diligence?

The duly performed due diligence is one of the key steps to success.

In order to have as smooth a process as possible, sellers should think in advance what information might be needed, make a checklist and assemble everything together, ready to be presented to the buyers. The areas of due diligence we will discuss below will give you an idea of what information that might be.

After reviewing the prepared package, the buyer has to conduct their own investigations to make sure the provided information is complete and accurate.

In a proposed merger or when shares of stock in the acquiring company constitute a major part of the purchase transaction, the target company might perform its own due diligence on the acquirer.

But you don’t have to be on your own. Due diligence is usually carried out by specialist consultancy organisations, representatives from the purchasing or investing company, or by staff within the target business. Sometimes an accountant with expertise in M&A might be involved as well.

The final result of the whole process should be a professional due diligence report with the following sections in it:

1. Corporate records
2. Financial information
3. Indebtedness
4. Employment and labour
5. Real estate
6. Agreements
7. Supplier and customer information
8. Legal

Sometimes the most important and crucial information of the Due Diligence Report (DDR) is summarized in an executive summary. A well structured executive summary has to be prepared if the Due Diligence Report is addressed to executives. They are very busy and need everything essential to be summarized in several sentences.

The scope of due diligence depends on the type of transaction, the perceived risks and each party’s needs.

Now let’s have a look at the different areas of due diligence that should not be overlooked.

Types of due diligence

As a matter of mergers and acquisitions (M&A), due diligence has two forms - hard and soft.

“Hard” due diligence is concerned with the numbers, while “soft” due diligence is about the people within the company and in its customer base.

Now, the main types of due diligence enquiry are the following, according to the Corporate Finance Institute:

Legal

Legal due diligence is crucial because it identifies any legal and business risks and concerns affecting rights or obligations of the target (ownership of property, equipment or vehicles, employment disputes, ongoing litigation, intellectual property, client contracts).

This is where your lawyer or team of lawyers come in handy. They will be able to check this for you and find out if there are any outstanding regulatory and litigation matters.

Moreover, legal DD involves examination and review of all important documentation such as (the example below is for a DD of a company or business):

• commercial register excerpts if not publicly available,
• copy of Memorandum and Articles of Association,
• minutes of board meetings and all meetings or actions of shareholders in the past several years (depending on the type of business),
• copies of share certificates and all companies’ books and records,
• guarantees provided to third parties,
• material contracts,
• contracts concluded on a non-arm’s-length basis,
• partnership agreements,
• employment, especially key employees,
• licensing or franchise agreements,
• loan and bank financing agreements,
• insurance policies.

All information presented in the Data Room and afterwards in the Due Diligence Report must be accurate, especially the financial one, because otherwise there might be serious consequences such as criminal sanctions.

Furthermore, the information has to be presented and summarized in the most efficient way, e.g. the main findings concerning the material agreements can be presented in a table. The information from the Data Room should not be paraphrased, but analyzed. The most important aspects have to be outlined. The Due Diligence Report has to contain findings, the risks have to be identified and adequate mitigations have to be suggested.

The duly prepared Due Diligence Report will contain Q&A sessions with executives and key employees who have to answer important business questions and provide missing information. 

Our law firm in Bulgaria can easily deal with the legal side of your due diligence process, as well as efficiently coordinate the rest of its aspects, listed below:

Administrative

Verification of items such as facilities, occupancy rate and number of workstations to better determine all current operational costs and future ones if the buyer decides to expand the target business.

Financial

A thorough understanding and analysis of all of the firm’s financial information, including:

• audited financial statements,
• recent unaudited ones,
• the company’s projections and their basis,
• capital expenditure plan,
• schedule of inventory,
• debtors and creditors,

• customer accounts,
• cost,
• profit margins,
• internal control procedures,
• sales pipeline,
• debt situation.
• balance sheet.

Commercial

A review of the relevant commercial aspects such as:

• market conditions,
• competitor analysis,
• compliance with industry standards,
• potential impact of any upcoming legislation changes to the sector,
• general information on the target’s goods and services.

Asset

• a detailed schedule of fixed assets and their locations,
• lease agreements for equipment,
• sales and purchases of major capital equipment,
• real estate deeds,
• mortgages,
• title policies,
• use permits.

Human resources

Analysis of:

• total employees (current positions, vacancies, etc.),
• salaries,
• bonuses,
• employment contracts,
• HR policies,
• employee problems.

Environmental

Environmental due diligence is important because you don’t want to violate any major rule and be heavily penalized. A review of such elements is a must:

• the list of environmental permits and licenses,
• the copies of all correspondence with the relevant authorities and regulatory agencies,
• the company’s disposal methods and whether they adhere to the current regulations and guidelines.

Taxes

An investigation of tax liability and related documentation, what taxes the company has to pay and whether they are calculated properly. Verification of the status of any tax-related case pending with the tax authorities.

Intellectual property

• the schedule of patents and patent applications of the company,
• the schedule of copyrights, trademarks, and brand names,
• all related documentation and any pending claims cases by or against the company regarding violation of intellectual property.

Customer

A careful look at the target company’s customer base, including analysis of:

• the top customers,
• the service agreements and corresponding insurance coverage,
• current credit policies,
• the customer satisfaction score and related reports in recent years,
• a list of any major customer losses within the last 3-5 years with explanations.

Customer due diligence is a must when it comes to any major contracts with consumers. It consists of checking who your customers are by confirming their identity. Businesses must apply customer DD:

• when establishing a new ongoing business relationship,
• when completing a high value transaction,
• when a customer’s circumstances change,
• when there are doubts about a customer’s information,
• when suspecting money laundering or terrorist financing.

Operational

All of the company’s:

• procedures,
• location,
• inventories,
• supplies,
• management structure,
• staff levels and skills, 
• customer relations,
• specific insurance coverage.

Strategic fit

Evaluate how well the company fits in with the overall strategic business plan of the buyer. Think about technology, products, market access, key personnel, and more, depending on your goals.

Other important types of due diligence include IT networks, issues of stocks and bonds, research and development, sales and marketing.

Why should we help you with DD?

Now, if you are still unsure whether to turn to us, take a look at our extensive experience with due diligence.

We have assisted clients in structuring and enhancing their due diligence processes.  Examples of our expertise include:

• Acquisition of electric power stations and energy projects: preparation of analysis of the project's condition (due diligence);
• Acquisition of commercial real estate: due diligence including cadastral map analysis and investigation into possible restitution claims;
• Investigation of the current status of companies and their activities from material and legal point of view;
• Due diligence related to sale of property in Bulgaria.

What’s more, our law firm in Sofia, Bulgaria offers service not only in Bulgarian and English, but also in Russian and German.

Conclusion

It is usually not a legal obligation but it is crucial that you always exercise due diligence before signing a contract or starting an ongoing business or employment relationship so that you can identify any potential problems or unexpected liabilities. Better invest in preparation of a DD now to avoid costly mistakes and headaches later.

Due diligence is a lengthy and complicated process so trusted professionals will be needed. The experienced lawyers will not only thoroughly conduct the investigation, but also write a proper due diligence report containing all the necessary information and findings.

If you need assistance with DD or any related matters, simply contact our law firm in Bulgaria.