By Yulia Barnes, Founder and Managing Director at Barnes Law
Due diligence always plays a significant role in mergers and acquisitions [M&A], but it’s even more important when dealing with businesses in financial distress thanks to the risks they pose to all involved parties.
Acquiring a business that is in financial difficulty is not for the risk-averse and can lead to financial or reputational issues further down the line if not handled properly.
Navigating M&A transactions can be complex, and there are various rules and regulations to be considered including the Companies Act 2006, the Insolvency Act 1986, and the Corporate Insolvency and Governance Act 2020. According to the Office for National Statistics [ONS], the value of domestic M&A during 2024 Q4 was £8.6 billion, so it’s clear that there is a lot at stake.
Undergoing a thorough due diligence process increases the chances of a successful sale, provides the real market value of the company, and gives peace of mind to both sides. However, M&A transactions can be complicated and fast-paced and do not always go as planned, which can in turn impact the extent to which due diligence can be carried out.
In these scenarios, it’s important to be flexible and to adjust to the changing circumstances of each corporate deal to ensure the best outcome for both sides.
Why is due diligence needed?
Investors are advised to undertake all the necessary precautions when buying a company. An important part of these precautions is due diligence, which provides all the information needed to assess potential risks and to help with decision-making.
This process examines all different aspects of the business in question, including, but not limited to, company, financial, legal, customer, employee, and product or service information, as well as details on physical assets and IP.
Building a clear picture of the business as a whole means buyers are less likely to encounter any nasty surprises further down the line, and can make a measured decision when weighing up the pros and cons of merging with or acquiring the company.
Carrying out this process can be complicated, expensive, and time-consuming, and on occasion can lead to disappointment rather than peace of mind. Nevertheless, it’s an important step to take to future-proof any big decisions.
Making adjustments
The consequences of overlooking the due diligence process could be disastrous for any M&A transaction, but in the case of distressed transactions, a certain degree of flexibility is needed.
Distressed transactions take place under greater time constraints than other M&A transactions. Sellers of distressed businesses are likely to want to sell as quickly as possible to avoid any further damage to the company and its value, which then puts buyers under pressure to carry out due diligence more quickly.
In this case, the process needs to be altered with the best interests of both parties in mind. M&A transactions can be challenging and lengthy processes, and due diligence should not become another obstacle. Instead, a clear deadline should be set, and the areas of the business being reviewed should be reduced where possible.
For instance, if a buyer is solely purchasing assets, attention can be directed to checking asset contracts and leases, as well as the existence of any securities registered against the assets.
Being flexible and taking a common-sense approach helps to obtain the essential information promptly, speeding up the overall process.
Research is key
Another key aspect of due diligence is carrying out thorough research of the company in question.
First and foremost, all information regarding shareholders, directors, creditors and annual reports should be considered. In England and Wales this information can be found on the government’s Companies House website.
It’s also crucial to check whether the company has had any legal issues or claims made against it, as this can reduce the chances of missing important information that may negatively impact the buyer in the future.
Buying a distressed business can be risky, so having as much knowledge as possible of the current state of the company, as well as any previous issues, is vital. Failing to do so could lead to financial or legal problems further down the line.
Developing trust
Due diligence is not just about conducting research, but about actively developing a sense of trust between the buyer and seller. One way to develop this trust is through warranties or personal guarantees.
Designed to protect the buyer, warranties are guarantees made by the seller regarding the state of the business in question, and can cover areas such as finance, tax compliance, or employees. If they are found to make any false statements, the buyer may progress with legal proceedings.
Buyers are also encouraged to obtain insurance for their own benefit due to the risky financial nature of M&A transactions. It’s important to note, however, that if an insolvency officer is involved in the process, obtaining warranties or insurance may not be possible.
In any case, it’s crucial to build as clear a picture as possible of the business being acquired to pre-empt any challenges.
Final thoughts
Conducting the necessary due diligence is vital in ensuring a successful M&A transaction for both sides. Having a clear understanding of the business, any past issues, and any potential future problems is crucial when making such a big investment.
By its nature, carrying out due diligence can therefore become a long and complicated process, which may delay proceedings.
A flexible, adaptable approach is the way forward for ensuring the process not only runs smoothly and promptly, but also covers the key ground required, resulting in the best outcome for both parties.
