Due diligence is the official process, often conducted by lawyers, of appraising a business that is already in existence. A thorough due diligence involves an in-depth scrutiny of all aspects of the business, not only to ensure that all relevant information is known, but also to ensure that the price being paid for the business accurately reflects the true status and value of the business.
For a large business, this aspect of the appraisal should almost certainly be conducted by a lawyer to ensure that all contracts, liabilities and assets are fully understood. One of the first things that should be considered are the contracts that the business already has in place and will, therefore, transfer with the business on sale.
The vendor will normally require you to sign a non-disclosure agreement before they will forward any contract negotiations that are in place. As part of this non-disclosure, you will be requested to keep secret all details that you are given and to agree not to use information for any other reason other than for due diligence.
Contracts that you will have to look at include ones such as supplier agreements, customer contracts, maintenance contracts, employment contracts and premises leases. Under normal circumstances when a business is sold, the new purchaser will step into the shoes of the vendor and assume the responsibilities and liabilities of the original owner.
As a matter of law, it is not possible for the liability of a contract to be transferred to a third party. Therefore, as a new owner, you will have to ‘novate’ the contract agreeing to assume the responsibilities of the previous party. Novation involves the third party (i.e. you as the new buyer) extinguishing the original contract and entering into a new contract. This is an opportunity to renegotiate terms, although it should be noted that large or substantial changes will not normally be entertained at this stage of negotiations.
Assignment of a contract is possible and this involves the new owner stepping into the shoes of the original party. But, it is not possible to assign an obligation without the full written consent of all parties. It is also necessary for the original contract to include a clause that permits assignment.
A good way of conducting a legal review of contracts is to go through each contract, writing down in two separate columns the rights and obligations that you will be receiving under the contract, for example, the right to occupy a certain amount of floor space within the office for £x a month. In a separate column you should also make a note of the practical implications in terms of how the contract can be transferred and the length of the notice period required should you decide to terminate the agreement.
Legal due diligence is a specialist skill and, in most cases, is one that should be conducted by experienced lawyers;
it will be normally necessary to sign an agreement not to disclose any information received during the due diligence process, in order to ensure secrecy;
during the process, you will need to go through all the contracts ensuring that you understand fully all of the liabilities and benefits that you will obtain when taking over the businesses contracts, after the sale.