To what level of detail is due diligence customarily undertaken?
Mergers & Acquisitions (2nd edition)
In most of the M&A transactions, the acquirer would usually conduct financial, business and legal due diligence on the target company.
In respect of legal due diligence, the acquirer would usually investigate the statutory books, major agreements and service agreements, details of leases, any loan and financing transactions, licenses and permits, as well as the particulars of any litigation and proceedings of the target and its group companies. The acquirer would usually submit a questionnaire to the seller (and/or its legal counsel) in respect of the target company. A legal due diligence report would usually be prepared, which could be comprehensive or relatively simple, reporting on disclosure against warranties given in the sale and purchase agreement. If the target company has assets and/or operations in China, it is usual practice for the acquirer to undertake a more in-depth and extensive due diligence.
An Offshore Listing Vehicle usually occupies the holding position in a corporate group structure. As part of the legal due diligence, an acquirer will normally carry out searches of publicly available information relating to the Offshore Listing Vehicle and its group companies. In Hong Kong, this will usually consist of searches at the relevant governmental authorities and registries, for example (and where applicable), the Companies Registry (in respect of the incorporation and registration of the target company), the Land Registry (in respect of the ownership of real property, mortgages and charges and other matters in respect of real property), the Trade Marks Registry (in respect of ownership of trademarks), the Patent Office (in respect of ownership of patents), the Official Receiver’s Office (in respect of any petition for compulsory winding up), and the Court Registry(ies) (in respect of any proceedings that have been taken). This serves as an independent check against the information and documents provided by the seller.
Please refer to the relevant Offshore Chapter for the level of detail of due diligence customarily undertaken in respect of such holding companies in the respective offshore jurisdiction.
In Austria due diligence procedures in most cases are conducted in a detailed manner. However, some companies prefer a two-step approach, meaning that in a first step a high-level due diligence analysis is conducted in order to identify red flags or deal breakers, and depending on the results of such first step analysis then conduct a more comprehensive and detailed due diligence analysis regarding the target.
The specific scope and level of detail of a due diligence procedure further depends on the size of the transaction and the business sector and also differs between private acquisitions and public takeovers. Due diligence analysis for private acquisitions are usually comprehensive (especially since financing banks usually request a detailed due diligence), while due diligence analysis prior to a public takeover are usually comparably limited.
One due diligence topic that is particularly important in Austrian transactions is the strict prohibition of the return of equity to shareholders (Verbot der Einlagenrückgewähr). Under this prohibition, affiliate transactions, including those between shareholders and the target, are subject to being null and void if the transactions are not on an arm’s length basis. This strict prohibition can also impact the protections a purchaser or seller needs to seek contractually.
In private M&A transactions, it is common for a detailed diligence exercise to be undertaken where the selling shareholders or selling company will provide answers and information in response to a due diligence request list provided by the buyer and its advisors. In an auction situation, it is often the case that a due diligence report is provided by the seller(s) as part of the auction process which contains information on the target company or business. Sellers typically offer the buyer or interested parties in an auction process, access to an electronic data room containing information on the target company or business and the sellers will run a Q&A process in conjunction with the data room review to answer questions raised by the buyer or interested parties. There may also be target company or business management presentation sessions that are organized by the seller.
In a public M&A transaction, the amount of diligence information provided by the target company will in large part depend on whether the transaction is recommended or hostile. In a hostile bid situation, it is unlikely that a bidder will receive anything more than the information that is publicly available. In a recommended deal, target company management are likely to be made available to the bidder team and there may be further information provided in addition to that which is publicly available. However, even in a recommended bid situation, the amount of information provided is unlikely to be the same (and to the same level of detail) as in a private M&A transaction. One reason for this is because the Code provides that any information given to one bidder must be made available to any other bona fide bidders (however unwelcome those other bidders may be). For this reason, a target company in a recommended bid situation will, in most circumstances, look to limit the scope and/or timing of the disclosure of valuable, proprietary commercial information that may be of interest to a competitor.
The scope and level of detail of the due diligence would depend on the structure of the transaction, the size of the acquired business and the specific sector regulations among others. Typically, the legal due diligence could cover general corporate information, title to shares, title to real estate and material assets, financial agreements and related security, other material agreements, IP, regulatory matters, employment, and pending litigation proceedings. Tax, financial and technical (if needed) is also performed.
Due diligence customarily focuses on the target’s current state of affairs, as well as historic overviews, especially where primary focus is real estate ownership or the acquisition of regulated businesses. Depending on the magnitude of the contemplated transaction and the size of the target’s business, law firms may set up materiality and quantitative thresholds for the review of contracts, ongoing disputes, real estate properties, etc.
Transactions in Colombia usually require a reasonable level of scrutiny over the company’s operations and assets. The most important information requested is normally related to tax, litigation, regulatory and labor issues and, depending on the type of operations of the target company, other areas may become relevant, such as environmental and data protection matters. Compliance is also becoming a key area to be analyzed in certain industries.
In an asset deal the due diligence is more restricted than in a share deal, except for labor, tax and environmental matters as certain liabilities related to such areas may be transferred by operation of law to the acquirer.
Considering the above, negotiations usually commence with the execution of a non-disclosure agreement, letter of intent or memorandum of understanding and the access to a virtual or physical data room.
The scope of due diligence undertaken usually differs between private acquisitions and public takeovers. If the target is a listed company, the level of due diligence required is generally moderate given the extensive mandatory disclosures monitored by the target. The standard of due diligence in private deals is more rigorous since publicly available information concerning the target company will be rather limited, but market practice is moving towards a risk-only approach and red flag reports to avoid cost-intensive exercises. Vendors due diligence reports are becoming more common practice than in the past to facilitate sale processes.
The level of due diligence undertaken by a bidder in the New Zealand market will typically vary based on the nature of the transaction, size and complexity of the target business and identity of the bidder, although an increase in the use of warranty and indemnity insurance in the New Zealand market is driving a need for bidders to undertake more comprehensive due diligence exercise.
Legal vendor due diligence is generally undertaken as part of a competitive sale process, but is less common on any transaction that proceeds by way of a bilateral negotiation or outside a formal sales process.
The level of due diligence undertaken in relation to a takeover transaction will depend on the nature of the transaction and co-operation of the target company. In the case of a scheme of arrangement, a full due diligence is more common as the transaction proceeds with the agreement of the target company board.
There is no specific level of detail for a due diligence exercise as it varies depending on the acquirer, the target company’s activity and the company’s compliance with the regulations of its industry. While some acquirers may opt for a limited high level due diligence with a focus on key red flags, others may prefer carrying out a full detailed due diligence.
As Cayman Islands companies tend to occupy the holding or top-co position in corporate group structures, due diligence is usually limited to the existence of the company, the terms of its securities and any shareholder arrangements (such as voting or registration rights agreements). Where the company is engaged in a regulated sector or is an operating company, verification of such licences and those operating agreements (and their terms) is typical.
Generally, the number of details disclosed regarding target companies involved is rather high in private acquisitions. Less information tends to be shared in public takeovers.
A further element likely to affect the extent of disclosure is the nature of the counterparty-buyer: if a competitor, the target company generally prefers to share information to the minimum extent possible due to the inherent risks if the transaction does not go through.
Due diligence carried out by a bidder in a public takeover will usually be more limited than in a private deal. In both recommended and hostile bids, due diligence includes a review of publicly available documentation.
On a recommended bid, the bidder will undertake due diligence itself, using publicly available information, before approaching the target. If the target is prepared to support the offer, the bidder will usually follow up its own detailed investigations by presenting the target with a list of matters on which it requires further information before it will proceed with the offer.
In a hostile bid, the bidder will have the same aims but will be limited to information which is available to it through the public domain and the level of due diligence will usually therefore be very limited.
Due diligence exercises in sophisticated M&A in Brazil is usually very deep and detailed, even in the case of listed companies. It involves at the very least legal, financial and accounting specialists, plus specialists in the industry where the target operates. Due diligence usually starts immediately after the execution of an NDA, which in some cases is coupled with an exclusivity agreement, and lasts until the very last day before the execution of the definitive agreements.
Subject to the activities of the specific company the following documents are customarily reviewed in such a due diligence exercises:-
(a) the constitutional documents of the company (i.e. its memorandum and articles of association and any resolutions amending the same);
(b) the corporate registers of the company (which shall include, the registers of registered offices, directors, secretaries, members, transfers and charges);
(c) up to date certificates issued by the ROC in relation to the Incorporation; name of the company; Registered Office; Director & Secretary; Shareholders; Share Capital and No Winding Up of the company;
(f) details in relation to any existing mortgages / encumbrances / floating charges or other obligations as registered with the ROC and/or relating to assets owned by the company;
(j) signed copy of the most recent Annual Returns filed by the Company with the ROC and evidence of payment of the annual levy;
(k) any organisation chart of the group, shareholding agreements, intra-group and financial agreements etc; and
(l) any list of lawsuits, arbitration or other disputes currently pending or soon to be initiated and review of any judgments/decisions/opinions rendered by the courts or relevant governmental agencies and claims by any third parties.
As stated above, subject to the specific business of the company due diligence may be exercised in relation to any regulated activities of that company as well as in relation to any industry specific agreement and/or commercial arrangement that may be in place.
The level of detail of a due diligence in the Norwegian market is normally transaction specific and, thus, may vary substantially depending on a number of factors. Such factors include (i) whether the deal involves a listed or non-listed company, (ii) the nature of the company's business, (iii) the bidder's familiarity with the target company, (iv) the relative bargaining strengths of the parties involved in the transactions, (v) the nature and size of the consideration, (vi) the nature and size of the consideration and (viii) the involvement of the competing bidders in the process and (vii) whether it is an acquisition of shares, business or assets.
Due to the above mentioned factors, it is difficult to provide a general statement applicable for all transactions. We have however seen that since the 2008 financial downturn, buyers in general have had an increased focus on a target's operational, financial, tax and legal position. A bidder's desire to conduct a wide range due diligence investigation will normally include a comprehensive financial due diligence, focusing on margin development, assessment of the business' underlying profitability, net debt, working capital, cash flow and investment requirements, budget assumptions, transactions with related parties, accounting principles and quality of financial information. Also the tax due diligence will typically be fairly detailed looking at pending tax issues with the authorities, dividends and group contributions, reorganisations, foreign exchange gains/losses, deferred tax positions, R&D costs, transfer pricing and other related parties issues, transaction bonuses, earn-outs, VAT etc. The legal due diligence may, however, have a more limited scope, but will typically focus on corporate governance, change of control issues, material contracts, real estate issues and potential environmental liability, separation issues and related parties, licenses, permits, need for public approval, employees and pension law issues, IPR, disputes, competition law issues etc.
A private equity buyer will normally also retain specialist consultants to carry out a detailed commercial due diligence which frequently includes a review of the market (trends threatening the target’s position etc.).
Depending on the transaction’s scale and the nature of the target business, it has also become fairly common to request specialist environmental due diligence reviews, specialist insurance due diligences reviews, specialist IT due diligences etc. Lately, so-called environment, social and governance due diligences have also become increasingly popular among private equity buyers. Often such buyers may further desire to carry out a more specific anti-bribery /anti-corruption due diligence.
Due diligence continues to be a challenge in Myanmar, reflecting the poor record keeping and compliance of Myanmar companies, lack of familiarity with due diligence and sensitivity to disclosing company information. Prospective acquirers are advised to engage early with potential target companies to explain the purpose and nature of due diligence procedures and build the relationships required to ensure an appropriate quality of disclosure.
A typical buyer will arrange for legal, accounting and tax due diligence exercises before deciding on an acquisition, depending on the acquirer’s risk profile. When financial and legal due diligence is undertaken, the acquirer may have access to the financial and legal books and records of the company, including tax books and records, corporate information not limited to corporate governance, copies of key client contracts (sometimes redacted), commercial contracts, financial contracts, assets and real estate property, pending or threatened litigation, environmental licences, intellectual property, insurance and internal auditors’ reports, et.al.
The scope of the research is usually limited at the first stage, whereby the potential acquirer receives information by reviewing published data related to the target company. In the following stage, a more detailed due diligence review may be allowed for those acquirers which have submitted an offer. Finally, the preferred acquirer may be granted the opportunity to perform an update due diligence before signing the transaction agreements.
Target’s due diligence reports are prepared in a number of deals. On the other hand, should little or no prior due diligence occur, then detailed protection clauses are negotiated and incorporated in the transaction documents, such as changes in the price or penalty clauses.
Generally, the scope of due diligence is rather limited in public takeovers compared to private acquisitions, and in the case of a hostile offer even limited to publicly available information. In the case of a friendly bid supported by the management, the due diligence may be more extensive, although the target board will have to decide carefully how much information it is appropriate to disclose, taking into account its fiduciary duties, the interest of the company and insider regulations.
In general, a party which receives confidential price-sensitive information about a target would be subject to insider trading restrictions unless that information was made public and, with a few exceptions, the bidder may be prevented from dealing in target shares or proceeding with the offer unless the relevant information is made public or ceases to be price sensitive prior to the acceptance period. It is generally accepted that, where a party intends to make a takeover bid (or enter into a merger) from the outset, and the due diligence merely confirms this intention, acquiring shares in the target in furtherance of the initial plan will not be prohibited, even after the receipt of due diligence information.
Generally, any bidder is advised to carry out as much due diligence as possible, as the possibilities to withdraw after announcement of the bid may be very limited. If the bidder is permitted to conduct due diligence, the bidder will usually be given only limited information during a limited period of time.
In private M&A transactions, highly confidential information is typically disclosed after the indicative bid or binding offer as confirmatory due diligence, or in a special data room to which only very few experts have access.
In private M&A deals, it is common to undertake a due diligence. The scope usually covers financial, tax and legal aspects of the target company.
In public M&A, the level of detail will typically depend on:
(i) the friendly (recommended) or hostile nature of the public offer, which will cause the board of directors of a target company to be more or less willing to share information respectively; and
(ii) legal restrictions that may limit information sharing, such as the corporate interest, the confidentiality obligation of directors, equal treatment requirements and restrictions in view of market abuse regulation.
7.1 In the context of public companies (whether listed or unlisted):
- the standard expectation of target companies and vendors is that purchasers should rely solely or primarily on the information available on the public record;
- on a case-by-case basis, some target companies and vendors will consider facilitating the conduct of due diligence, to an extent which is in most cases significantly limited; and
- in any event, target companies and vendors need to take care to avoid contravening Vietnam law prohibitions against insider trading, in connection with the disclosure and receipt of information which is not on the public record but which may be price-sensitive.
7.2 In the context of private companies, historically Vietnamese companies and vendors have been uncomfortable with the concept of due diligence and have been resistant to facilitating the conduct by prospective purchasers of detailed due diligence investigations. After more than two decades since Vietnam first opened its doors to foreign investment, however, the need for foreign investors to conduct detailed due diligence investigations is now widely appreciated in Vietnam, and target companies and vendors are increasingly willing to allow sufficiently transparent and detailed due diligence investigations to be conducted.
7.3 In many (but not all) cases nowadays, Vietnamese target companies and vendors are generally prepared to facilitate the conduct of due diligence investigations which approach the levels of transparency and detail to which investors from more developed jurisdictions are accustomed.
7.4 On the other hand, Vietnamese target companies and vendors:
- are in many cases strongly resistant to the use of electronic data rooms and/or the delivery to purchasers or their advisors of copies of documents (whether in hard copy or electronic format);
- in many cases will insist on the use of physical data rooms only, normally on-site at the target company’s premises, with no opportunity for the prospective purchaser or its advisors to take copies (whether in hard copy or electronic format);
- in many cases will be inexperienced with handling due diligence processes and will struggle to identify, locate, collate, and present in an orderly and comprehensive manner the information and documents having been requested for disclosure; and
- in many cases, will be reticent to incur costs in engaging legal, financial, accounting, and/or tax advisors to assist them in handling due diligence processes, instead seeking to rely on internal employee resources who lack the time and experience to manage an adequate and efficient due diligence process.
7.5 As a result of the factors outlined in Section 7.4 above, it is in many cases not possible, from a practical perspective, for foreign investors to conduct due diligence investigations to the degree of transparency and detail to which they are accustomed when conducting M&A transactions in more developed jurisdictions.
The scope of due diligence review in negotiated public transactions varies considerably from case to case. Typically, however, the scope is much more limited in a public deal, as the level of public disclosure is higher for listed companies than for private businesses, especially as regards the financial reporting (see question 6).
A potential acquirer of a public company would typically start conducting a desktop due diligence based on publicly available information. In a second stage, a bidder would ask the target company for non-public information on equity plans and outstanding equity instruments, change of control clauses in commercial and financing agreements, terms of employment of executive management, intellectual property, compliance with laws, material correspondence with SIX and other key regulators, litigation and other matters.
Due diligence normally covers four aspects of a company’s business:
- Operational and business matters;
- Tax matters;
- Financial and accounting affairs;
- Legal issues.
Sometimes also environmental due diligence is undertaken.
The level of detail will depend on numerous facts, such as background and experience of the target company, scale of business, general current situation in the market, and may be limited to quick diagnostics or may include deeper analysis.
The usual scope of legal due diligence includes corporate matters, real estate and title to other substantial assets, loan and financial matters, material contracts, including contracts with key customers and suppliers, disputes and litigations, regulatory affairs and investigations and employment matters.
The level of details is decided on a case by case basis. Time limitations (e.g. the previous three years) and materiality thresholds (e.g. exposures over EUR 100,000) usually apply.
Ordinarily a due diligence will be undertaken although it is not required by law. A due diligence will look at various matters including corporate & shareholder Information; government & regulatory matters; details of assets; financial position & statements; financial obligations & commitments, material contracts, real estate, insurance policies, taxation position & issues, employees, intellectual property & technology, litigation, arbitration & other disputes.
Compared to other jurisdictions, buyers of public companies in the U.S. usually conduct due diligence to a relatively high level of detail. The scope of diligence in private deals is typically even greater since the amount of publicly available information concerning a target company will often be extremely limited. By contrast, the scope of diligence in hostile deals is usually quite restricted since potential acquirers must rely solely on information that is publicly available.
For private deals in Sweden due diligence reviews are regularly conducted by the buyer and its advisors on all relevant matters. A typical “Swedish” due diligence is in our experience in line with the scope and level of corresponding reviews in other highly developed transaction countries if not even more detailed. The need for a buyer to be thorough when conducting its due diligence review is further underlined by the fact that it is market practice in Swedish private M&A share sale and purchase agreements that all information included in the due diligence data room in reasonable detail and context is considered “disclosed” to the buyer in a way that excludes seller liability in case of breach of a seller’s warranties based on such disclosed information.
A pre-takeover due diligence in a public offer is usually more limited in scope than in the case of a private acquisition.
Acquirers of public or private companies in the Philippines typically conduct due diligence at a high level of detail.
This varies between transactions, however as a minimum a bidder would usually obtain as much information from public sources as possible in combination with approaching the target’s board of directors with a comprehensive list of financial, legal, regulatory and operational due diligence questions and requests.
Physical assets may also be inspected and certain assets, such as real property, may be valued independently.
The Takeover Code contains provisions relevant to due diligence requests in a hostile bid.
It is common for an acquirer to perform due diligence in an M&A transaction in Japan. The level of detail of such due diligence depends on various factors, including the size of the transaction, the nature of the target company’s business and the amount of time available for the diligence investigation.
Isle of Man
This will depend upon the nature of the transaction but legal practice in the Isle of Man follows the legal practice in England and Wales.
A potential offeror would usually obtain as much information from public sources as possible before approaching the target company with a list of financial, legal, regulatory and operational due diligence questions and requests.
Due diligence, as in most established and recognised jurisdictions, is customarily and commonly undertaken. It would be a very rare occurrence where due diligence would not be undertaken unless where a competing bidder forgoes due diligence as a completive advantage. However, as noted above, if the bid is hostile then the only information which might be available for due diligence would be that in the public domain. As also indicated above, the target company may look to limit the scope of due diligence undertaken and, in particular, withhold sensitive financial and business information until it is clear the bidder has a genuine interest in proceeding with the transaction.
British Virgin Islands
Customary due diligence will take the form of reviewing the memorandum and articles and any other public information filed with the Registrar as set out in question 6 above. The registered agent of the target company will be asked to provide copies of the target company’s registers of directors, shareholders and charges. Copies of all material contracts, the minute book and financial statements are also routinely requested.
In the case of a hostile bid the amount of due diligence information will be limited to the public information available from the Registrar and any other information in the public realm.
In the case of a hostile bid, this would usually be limited to information from public sources. For a recommended or supported bid, public information may be supplemented by the target providing an electronic data room and/or responses to a list of financial, legal, regulatory and operational due diligence questions and requests.
The Takeover Code, if it applies, may require a target to provide equivalent information to competing bidders and/or govern the questions that can be raised by a bidder.
Due diligence in an acquisition has commercial, legal, financial, tax, and, in certain cases, technical or environmental aspects, depending on the type of activities conducted by the particular target company.
Legal due diligence typically covers a review of the target company’s legal documentation, agreements material to the target company’s business, compliance with any regulatory requirements, assets, legal disputes, and any potential red flag issues that may be of importance to the acquirer.
This will largely depend on the nature of the transaction and agreed scope of diligence by the parties. Diligence audits are generally very detailed and extends to legal, financial, environmental, taxation and commercial due diligence. Documents reviewed in the process includes records at the companies’ registry, litigation files, contracts, financial statements (sometimes with the Auditor’s management letter), licenses, minutes of board and shareholders’ meetings and sanctions.
Due diligence is usually carried out to a level as requested by the buyer. The requested level of due diligence customarily depends on various factors such as: the size of the target, the share to be acquired, the type of the acquirer, or the aim and expectations of the acquirer. Due diligence will most probably be a more in-depth and specialized one if the target is a large enterprise, if a majority share is acquired, if the acquirer has sector specific expertise or if the acquirer intends to take the business further and to expand it. On the other hand, the due diligence will most likely be more limited in scope if the target is a smaller company or a start-up, if only a minority share is acquired as a result of the transaction, if the acquirer has less sector specific expertise or if an exit is foreseen in the short or medium term. Also, the depth of the due diligence isusually aligned with the volume (value) of the transaction: transactions of less deal value commonly allow a higher level due diligence.
More recently, transferring shareholders and target companies have become more conscious and diligent to limit the due diligence in accordance with the target’s interests for protecting its business secrets, and for keeping the target’s confidentiality obligations.Also, considerations under applicable data protection and competition laws are becoming more and more important in the context of disclosing information in the course of the due diligence. These considerations, more than before, lead transferring shareholders and target companies to apply a more conscious and structured approach to the due diligence. Therefore, due diligence is confined to redacted information in certain cases. Sometimes, due diligence is divided into phases where only limited and less business sensitive information is shared with potential acquirers in the beginning and more sensitive information is disclosed only at a later stage or to a limited number of addressees. Also, more emphasis is put on having proper non-disclosure agreements in place.
The above trend has intensified following the publication of Notice No. 1/2017 of the GVH on forbidden information sharing in the context of mergers and acquisitions and the GVH’s recent enforcement practice. We anticipate that the entering into effect of GDPR will further promote legal consciousness when it comes to the disclosure of information in the context of M&A.