What is due diligence?

Most sales of independent businesses are dealt with by selling the assets of the business for an agreed price. The assets will usually comprise the lease, goodwill, tenant’s fixtures and fittings, movable assets and stock.

The purpose of due diligence is risk management. The buyer will investigate legal, financial, accounting and taxation issues. Since the principle “buyer beware” applies, and the Seller is under no duty to disclose defects or liabilities in the business, the buyer must conduct its own, careful investigations.

A checklist should include the financial, legal, and operational detail of the business. You should ask the owner of the restaurant or pub for a list of things which is likely to include those under Due Diligence below.

Heads of Terms

It is advisable to spell out the terms in principle at the outset so that the lawyers for both seller and buyer can work within an agreed framework, which will help to avoid misunderstandings or arguments later in the proceedings.

Property issues to consider

Title checks and searches should be carried out by the Buyer’s solicitors to ensure a good and marketable title. Where the premises are leasehold, it is most likely that a transfer of ownership will require landlord’s consent, such consent not to be unreasonably withheld. The requirements of the landlord for granting licence to assign should be addressed early in the transaction, in order to avoid delays and problems. These would include taking up references on the buyer. The landlord’s costs will also need to be paid at an early stage.

Due diligence information

The Seller’s solicitor and accountant, as applicable, should prepare:

  • A legal pack with all relevant legal documents relating to the business and the property from which it trades.
  • Financial information including balance sheets, income statements, management accounts and tax returns.
  • Information regarding employees and the business’s organization. This includes employee handbooks, information about salaries, schedules, and employee benefit plans.
  • replies to a standard set of commercial due diligence enquiries. These cover a wide range of topics including ownership of assets, employees and rights to be transferred under TUPE Regulations, pension arrangements, details of any disputes, corporate matters and liabilities to taxation.
  • Replies to commercial property enquiries (including CPSE1 or CPSE7).
  • All records regarding the legal standing of the business, including leases, planning permissions, insurance policies (buildings and public liability), contracts, alcohol licences, premises licences, food hygiene certificates, PRS for music licence, sitting out licence for any tables and chairs outside the premises, and any patents or trademarks the business may own.

Disclosure letter

The Seller’s solicitor will prepare a letter making specific disclosures. This is how the Seller can protect itself against potential liability for breach of warranty. The disclosure letter will make specific disclosures against specific warranties, as well as general disclosures of matters in the public domain including searches and company registration documents. These disclosures are likely to be negotiated between the parties.

The Buyer’s solicitor will usually deal with:

  • A list of additional enquiries they wish to raise based on the information supplied and the results of their searches.
  • Carrying out of relevant searches. These would typically include company, local authority, water and drainage, environmental, planning and any other relevant searches.
  • Prepare the initial draft sale and purchase contract, and draft deeds of assignment of the lease, goodwill and any third party contracts of the business.
  • Reporting on Due Diligence findings to the Buyer.

Forward Planning

As with most commercial transactions, the key to a speedy and successful transaction is preparation and getting all usual and necessary information ready at the outset of the transaction.