Due diligence

Due diligence is a valuable and key risk management tool used for buyers and businesses alike. Thorough due diligence investigations allow buyers to make informed decisions and avoid surprises at the end of a transaction.

Due diligence investigations empower buyers in ‘caveat emptor' (this means ‘let the buyer beware’). ‘Let the buyer beware’ means that it is up to the person purchasing the goods to make sure they are free from defects and fit for purpose.

Conducting effective due diligence investigations ensures that buyers ‘get what they pay for’.

The due diligence process can be lengthy and difficult. Depending on the transaction, buyers can interact with various parties (eg brokers, accountants, and lawyers) each with different levels of information, and incomplete records. The buyer will then review the information collected, and make further requests for more information if there are questions or missing details.

Due diligence can also affect the seller negatively. The process can distract the seller from actually running their business in order to respond to large volumes of questions and requests for documents.

To streamline due diligence, sellers should attempt to anticipate what information buyers will ask for and assemble it in one package. This can include key documents and records relating to the business (eg accounting reports, competitor and market comparisons, and analysis of intellectual property rights).

After reviewing the prepared package, the buyer should conduct their own investigations to ensure that the information provided is accurate.

The scope of due diligence is dependent on the type of transaction, any perceived risks, and the party’s needs.

The most common transactions include:

• purchasing a business
• entering into a partnership
• entering into a major contract

Buying a business or entering into a partnership

Buyers have the right to look at the records, assets, and operations of a business before committing to purchasing or entering into a partnership.

The result of a due diligence exercise should be a complete story of the target company (or partner). This story should include information on the financial, commercial, operational, and legal position of the target business or partner.

Financial

This should outline all financial aspects of the company (eg debts, profit/loss ledgers, and the accounts of any wholly-owned subsidiary company). Buyers can access a business’ latest accounts, annual returns, and company reports through Companies House (where all limited companies in the UK must register).

Commercial

This should include a review of the commercial aspects relevant to the target (eg market conditions, competitor analysis, compliance with industry standards, impact of any upcoming legislation changes to the sector, and general information on the target’s goods and services).

Operational

This should collate all of the company’s procedures, its location, inventories, suppliers, management structure, staff levels and skills, customer relations, and specific insurance coverage

Legal

This identifies any legal risks affecting the rights or obligations of the target (eg ownership of property, equipment or vehicles, employment disputes, ongoing litigation, intellectual property, and client contracts)

All information presented, especially the financial information must be accurate otherwise the individual directors may be exposed to criminal sanctions.

Entering into a major contract

In addition to the investigations required above, major contracts with consumers can also be affected by anti-money laundering legislation or 'customer due diligence'.

Customer due diligence means taking steps to identify your customers and checking that they are who they say they are. Businesses can do this by taking their name, photograph of an official document that confirms their identity, residential address, and date of birth. The best way to do this is to ask for a government-issued document (eg passport), along with utility bills, bank statements, and other official documents.

Businesses must apply customer due diligence when:

• a new ongoing business relationship is established
• a customer’s circumstances change
• there are doubts about a customer’s information that was obtained previously
• money laundering or terrorist financing is suspected

Business must also comply with customer due diligence when your business carries out ‘occasional transactions’. ‘Occasional transactions’ are transactions that are not carried out within an ongoing business relationship where the value is:

• €15,000 or more if you’re not a high-value dealer (or the equivalent in other currencies)

• €10,000 if you are a high-value trader (or the equivalent in other currencies)

This applies whether it’s a single transaction or linked transactions. Linked transactions are individual transactions of less than €15,000 (or €10,000 for high-value dealers) that have been deliberately broken down into separate, smaller transactions to avoid customer due diligence checks. Your business must have systems in place to detect potentially linked transactions. For more information, read the government's guidance.

If you have doubts about a customer’s identity, you must not continue to deal with them until you are.