DUE DILIGENCE: PROTECTING NEW INVESTMENTS AND ACHIEVING SUCCESSFUL NEGOTIATIONS

The expression «diligence is the mother of good luck» is widely known. Doing your due diligence, your hard work, research, investigation, or analysis, is a process that is used with equity in our day-to-day life choices, as well as more specifically in legal, financial, and market audits. 

Understanding how due diligence is systematically applied in commercial investment negotiations may help you manifest good luck in your own decision-making, whether you are in the same process or striving to exercise a standard of care in other vital choices in your life. 

Why are we interested in explaining and understanding the concept of commercial due diligence?

In a business context, due diligence answers the following question: Does the company being acquired comply with the legal requirements? And, if we know this information, many core variables that impact the valuation of the asset, and therefore the negotiation, will be better understood. 

Due diligence is fundamental, as it involves verifying the actual status of an asset, such as a company, during negotiations and before acquisition. This process allows us to review the target company’s financial and legal situation before a significant transaction, such as a merger, acquisition, or investment.

What is the lawyer’s role in due diligence?

The lawyer’s role in the due diligence process is to define and conduct a narrow legal analysis. In other words, our mission is to determine, from the outset, the scope and purpose of the review.

What should be considered regarding the scope of due diligence?

The reach of the due diligence investigation should address the specific needs of the business.

While it is true that due diligence generally focuses on reviewing financial projections, annual accounts for several fiscal years, the focus should remain on the most relevant legal aspects (mainly corporate, tax, labor, real estate, administrative, and contractual law) of the target company.

Below, we discuss the two review systems used to provide buyers with information.

1) The first is due diligence process is via a data room: this is a secure platform where the seller stores the collected information they deem relevant and makes it available in a room at their own offices, or even at a third party’s, accessible to the buyer for review. Commonly, there is an option to carry out this task virtually.

While there are many conveniences to this option, the consequences are that access to the data room is usually time-limited, and even then, printing the documentation is often prohibited. The virtual platform makes a thorough analysis of the information unfeasible.

2) In this second due diligence mechanism, the data provided by the seller is supplied in response to the buyer’s requests.

Let’s consider a business context, such as a tender for the purchase of a company—the so-called «beauty context» — which involves the auction of a private company through a tender process. The tender process has five stages: market research, the request for information, the request for quotes, negotiation, and contracting. Due diligence is an inherent part of the tender process.  

However, given the importance of due diligence in company acquisitions, a crucial aspect of an investigation is clearly identifying the object of the analysis.

In the analysis, the object is variable and can change depending on various circumstances. Therefore, the approach would differ when making an industrial investment from when making a financial investment. In other words, who is the intended recipient of the report? 

Our mission is to determine, from the outset, the scope and purpose of the review.

Variables, such as whether the report is directed toward the seller or the buyer, will change the focus of the analysis. Different objects interpret the current situation and how to make informed decisions distinctly.

Just as differentiating between the object of the seller and buyer is essential, identifying the type of investor is also important. For example, an industrial investor will have a long-term investment focus aimed at strengthening their company, while a financial investor primarily seeks a return on their investment.

As you can see, it is not enough to just conduct your due diligence; you must also be aware that focusing on different objects or entities can change the nature of the investigation. In our next article, we will explain the due diligence analysis process in more detail to help you achieve a more successful outcome.