To what level of detail is due diligence customarily undertaken?
Mergers & Acquisitions (3rd edition)
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.
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.
Although the level of due diligence may vary depending on several factors, such as if the target company is a publicly traded company or privately held company, the industry in which the target company operates, the statutory auditor of the target company, sophistication of the management of the target company, among others, due diligence will normally be made in two stages (i) an initial due diligence, conceived as a “red flags report” that corresponds to a high level analysis and highlight of the most relevant legal issues, and (ii) a confirmatory due diligence, with a more detailed report and description of the business and main issues of the target company.
The acquirer would usually conduct financial, business, technical and legal due diligence of the target company. The scope and level of detail of due diligence may vary substantially depending on a number of factors, such as (i) whether the deal involves a listed or a non-listed company, (ii) the nature of the company’s business, (iii) the structure of transaction, (iv) the nature and size of an acquired business, (v) the specific sector regulations.
The scope of undertaken due diligence 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 extensive mandatory disclosures monitored by the target company. The standard due diligence in private deals is more rigorous since publicly available information concerning the target company will rather be limited.
Share deal: ordinarily deep in aspects related with labor, taxes, commercial contracts and environmental issues. Compliance in certain industries.
Asset deal: DD is more restricted but would include labor matters or environmental matters, or certain regulatory matters depending on the asset involved in the deal.
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.
Due diligence procedures are usually conducted in a detailed manner, including legal, tax/financial/accounting and technical matters depending on the target company and its assets. If W&I insurance shall be taken out, also insurers expect a customary level of detail of due diligence. Due to legal uncertainties regarding the ownership of real estate, title insurance is often used if real estate forms an important asset of the target.
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.
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 due diligence is usually more extensive, typically involving a full business review, verification of such regulatory licences and those operating agreements (and their terms).
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.
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. In the course of the due diligence exercise the interested acquirer may gain access to the financial and legal books and records of the target and information regarding third parties, such as key client contracts (sometimes redacted), commercial contracts, financial contracts, assets and real estate property, pending or threatened litigation, environmental licenses, intellectual property, insurance and internal auditors’ reports, et.al. Such information shall be restricted in terms of confidentiality and third party rights including data protection rights for individuals.
As a matter of practice, the scope of the research is usually limited at the first stage, where 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. The detail and extent of vendor’s and purchaser’s protection clauses, reps and warranties are a matter of negotiation.
Vendor’s due diligence reports are prepared in a number of deals to accelerate the process, while reliance letters may be negotiated between the potential acquirer and the report issuer.
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.
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.
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 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.
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.
Peruvian regulations do not contain specific rules regarding the detail of the due diligence the potential buyers may conduct; however, it is undertaken in almost all transactions (even if the target is a public company). Usually, in a due diligence, the information is separated in corporate, labor, tax, real state, litigation and criminal procedures information, as well as other relevant data related to the business operations and economic core activities of the target company (depending on the sector, it can be trademarks, environmental permits, etc.) Taking this into consideration, it will depend of the potential buyers to what level of detail they want to conduct the due diligence or in which section they want to focus.
The level of detail of a due diligence audit would depend on various factors such as the complexity of the operations of the target company, the trust between the contracting parties and the timeline and cost considerations for the M&A.
M&A would usually involve a legal, financial and technical due diligence audit. The legal due diligence would cover corporate and commercial matters, taxation, regulatory matters, material contracts, properties and assets, labor and litigation, and intellectual property.
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.
The due diligence process varies from deal to deal and generally covers financial, legal and tax matters. Operational and environmental due diligence are less common in mid-market transactions, except if the target operates in the specific sectors (e.g., real estate and tourism or industrial sectors).
The level of detail the due diligence is customarily undertaken depends on the characteristics of the deal and the appropriate balance between, amongst others, the comfort the client wants to take from such exercise, the opportunity cost to the client and the transaction costs with advisers.
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.
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, loans and financial matters, material contracts, including contracts with key customers and suppliers, disputes and litigations, regulatory affairs and investigations and employment matters.
This depends on whether the target company allows a potential offeror to conduct a due diligence investigation and the extent to which the acquirers know and understand the business and liabilities of the target.
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.
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.
In most of the M&A transactions, extensive due diligence is undertaken, which involves both financial / accounting and legal due diligence on the target company. The level of detail of the due diligence will depend on various factors, ranging from the nature of the target company to the size of the transaction. Usually, the acquirer will prefer a high-level due diligence analysis on the target company in order to identify red flags or deal-breakers.
In the case of an acquisition of a publicly listed company, it will depend on the transaction (with an auction, due diligence will probably not be possible) and the level of control the selling shareholder has in practice over the company. Very large acquisitions have been completed with reliance only on publicly-available information.
As in other comparable jurisdictions, the buyer should consider what level of due diligence is required based on the target’s business and the transaction’s circumstances. In the UAE, it is particularly important to verify the ownership of the target given that until recently, 51% of any onshore company, i.e. UAE companies incorporated outside a UAE free zone, must be owned by a UAE national or wholly owned UAE entity. Even though the FDI Law now allows 100% foreign ownership, this law is only applicable to companies in specific sectors.
Generally, in case of unlisted targets including companies, a very detailed diligence is customarily undertaken. This would cover matters right from incorporation of a target, to issuance of initial shares or other instruments to the founders, and matters such as compliance with various applicable laws including company laws, income-tax laws, foreign exchange management laws, environmental laws, intellectual property laws, etc. Internal agreements among founders and key vendors and customers are also analyzed threadbare.
As far as listed targets are concerned, subject to the limitations explained in answer 6 above, depending on the size of the deal, detailed diligence may be conducted
7.1 In the context of public companies (whether listed or unlisted):
(i) the standard expectation of target companies and vendors is that purchasers should rely solely or primarily on the information available on the public record;
(ii) 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
(iii) 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:
(i) 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);
(ii) 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);
(iii) 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
(iv) 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.
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.
Some PRC investors tend to neglect the importance of prudent due diligence and an informed decision-making process during the execution of M&A deals. Timetables can be unreasonably aggressive in a rush to close a deal and save on transaction costs. This may result in acquirors being exposed to material compliance and internal control issues as well as contingent liabilities without appropriate provisions in transaction documents. More prudent investors, on the other hand, tend to engage experienced lawyers, accountants, tax and financial advisors and other professional advisors to conduct thorough due diligence on a target company and to carefully assess relevant risks before making an investment decision. In the latter scenario, although investors may vary in terms of the level of detail in due diligence, our general observation is that parties tend to focus more on corporate history and compliance issues of a target company, among other areas.
The level of detail in due diligence usually depends on the acquirer’s choice and risk appetite, whether the target is listed or not, the size and value of the transaction and the domain of activity and complexity of the applicable regulatory framework. Private equity players and international direct investors customarily conduct full legal, financial, tax and technical due diligence prior to completing an important acquisition.
In practice, we are more often requested to conduct full due diligence rather than high level due diligence. However, most acquirers request issuance of a key issues findings report rather than a full detailed diligence report.
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.
In a typical M&A transaction, the acquirer conducts financial, business and legal due diligence on the target company.
In respect of legal due diligence, the acquirer (and its legal counsel) typically 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, who will prepare a disclosure letter in response thereto (and through which the seller is able to disclose certain factual matters against the warranties it will give to the acquirer in the sale and purchase agreement). A legal due diligence report would then be prepared for the acquirer by its legal counsel, which might comprise either comprehensive or high-level issues-only reporting. If the target company has assets and/or operations in China, it is usual practice for the acquirer to undertake 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 private M&A transactions, it is common for a detailed diligence exercise to be undertaken (which can cover legal, financial, commercial and tax matters) where the selling shareholders, selling company or management of the target company will provide answers and information in response to a due diligence request list provided by the buyer and its advisors, with information and documents also included in a data room for the buyer and its advisors to review. In an auction situation, it is often the case that a due diligence report is provided by the seller(s) (which the successful bidder will get reliance on) as part of the auction process which contains information on the target company or business and which may be “topped up” by the buyer and its advisors. There may also be target company or business management presentation sessions that are organized by the seller.
In a public M&A transaction, the buyer will initially conduct due diligence based on publicly available information. The extent of any further due diligence will depend on whether the offer is recommended or hostile. In a hostile bid situation, it is unlikely that a bidder will receive any further materials or support or interaction with the target company’s management team. In a recommended offer, 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, due to the Code’s requirement that any information given to one bidder must be made available to any other bona fide bidder (irrespective if such bidder is hostile), the engagement and level of disclosure of information is unlikely to be to the same level as in a private M&A transaction, even in a recommended bid situation to avoid commercially sensitive information being accessed by unscrupulous bidders.
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.
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 is usually 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. The entering into effect of GDPR has further promoted legal consciousness when it comes to the disclosure of information in the context of M&A.
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.
The level of detail to which due diligence is undertaken in each case depends on the particular agreement of the parties. The content and scope will depend upon circumstances such as available time, the value of the transaction, the business sector of the target company and the amount of costs the parties are willing to incur for this purpose. The higher the value of the transaction and the higher the risk undertaken by the buyer in case of realization of the purchase, the bigger the need for a thorough and detailed due diligence procedure. Often a two part procedure is carried out, whereby in the first instance a limited high-level overview is performed to identify any potential red flags, whereupon the decision is made whether a more detailed analysis should be conducted or not.