Ensuring informed decisions: The importance of due diligence

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14 December, 2023

Jaime Penaluna

When purchasing a business, the buyer will often undertake a level of due diligence. The due diligence process is a fact-finding exercise for the buyer to find out information about the business from the seller. The level of due diligence will usually vary depending on a number of different factors. The general principle in law is caveat emptor (buyer beware) and means that there are no protections for the buyer regarding the condition of the business that they are purchasing, subject to certain statutory provisions. Therefore, a buyer will seek to rely on warranties and indemnities that are contractual provisions in the purchase agreement that aim to protect the buyer. Further detailed explanation of warranties and indemnities is outside the scope of this article.

The Due Diligence Exercise

Typically, a buyer will issue a questionnaire to the seller and request information about all aspects of the business. The seller will need to provide responses to the questions asked about the business and provide copies of documentation relating to the business supporting their replies. Copies of documentation can be provided to the seller in a hard copy bundle although more commonly these days, documents are uploaded into an online 'data room' so that all parties and their representatives can have access to the due diligence. The level of detail required will depend on numerous factors, such as the complexity of the target business, any key contracts, key intellectual property, the relationship between the parties and the deal value. Commonly asked questions relate to the financials of the business, the business contracts, the employees, the properties and any intellectual property. When preparing for a sale, it is beneficial if the Seller starts to gather all this information at their earliest convenience to prevent any delays with the purchase. The due diligence process can be demanding for the parties as a lot of information can be requested and a lot of information will need to be reviewed. Further negotiations may become necessary depending on the outcome of the due diligence exercise. When the investigation into the business is nearing conclusion, typically the buyer's solicitor will prepare the first draft purchase agreement.

Formal Disclosure

Within the purchase agreement, the seller will give a range of warranties which are contractual statements which aim to protect the buyer. This is because, if the statements are found to be untrue and this has resulted in the buyer suffering a loss, then the buyer may be able to seek a remedy for a breach of contract. The disclosure letter is the formal protection that the seller would seek to rely on against a potential warranty claim. If a seller knows a warranty is not true, they should disclose against the warranty in the disclosure letter. If a warranty has been clearly disclosed against in the disclosure letter and meets the definition of disclosed in the purchase agreement, the buyer cannot bring a claim for breach of warranty. The disclosure letter is similar, but corollary with, the due diligence process. The buyer therefore needs to carefully consider the disclosures made by the seller and seek an indemnity or negotiate the purchase price if any issues arise.

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