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Due diligence requirements
What due diligence is necessary for buyers?
The level of due diligence that a buyer wishes to undertake will depend on a variety of factors, including:
- the target’s size, industry, ownership composition and financial health;
- whether the buyer is a strategic acquirer or a financial sponsor;
- the buyer’s risk tolerance; and
- the context of the transaction (eg, an auction process).
Buyers will often undertake a preliminary due diligence review of a target based on its financial statements and recent financial and operational performance. If a buyer decides to move forward, it will engage outside advisers (eg, financial advisers, tax accountants and lawyers) for an expanded diligence process, involving:
- ownership and governance;
- customer and vendor relationships;
- legal and regulatory compliance;
- real estate;
- labour and employment;
- intellectual property and information technology;
- tax; and
- employee benefit plans.
An outside adviser to a buyer will typically summarise its findings from the diligence process in a written report. This work product becomes particularly important where there are other market participants involved in the proposed transaction that rely on the buyer and its advisers to perform an adequate level of due diligence. For instance, a buyer’s lender or insurer (where applicable) will be entitled to review diligence reports prepared by the buyer’s outside advisers in the ordinary course.
What information is available to buyers?
Buyers may search public records at the state and county levels to:
- gather information concerning current and past liens perfected against a target’s assets;
- obtain copies of the target’s organisational documents; and
- confirm the target’s good standing status (ie, that all state franchise taxes have been paid).
If a public company is the target, filings and documents relating to its ongoing public reporting and disclosure obligations (including materials relating to past M&A and financing transactions) may be accessed through the Securities and Exchange Commission’s (SEC’s) website.
In the early stages of an M&A transaction, the information available to a buyer is typically limited to a confidential information memorandum or management presentation (summarising the target’s operations, business plan and financial forecast for potential buyers) and a virtual data room populated with basic background materials on the target.
As the transaction progresses (including, in the auction context, once a buyer’s bid has been accepted and the buyer has won exclusivity), the buyer’s counsel typically has the opportunity to deliver a more formal due diligence request list, listing information buyer’s counsel wishes to review in connection with due diligence.
The buyer’s counsel may also schedule due diligence calls with relevant management personnel from the target (and target’s counsel) on certain topics with respect to which due diligence is more easily conducted live.
What information can and cannot be disclosed when dealing with a public company?
Generally, when a public company is involved in an M&A transaction, selective disclosures are prohibited. Regulation Fair Disclosure requires that confidentiality commitments be obtained prior to making a selective disclosure. If a selective disclosure is made and trading in the company’s stock occurs as a result, the persons involved may be civilly or criminally liable on a theory of tipping.
Practical considerations also discourage premature disclosures regarding deals involving public companies. If a premature disclosure occurs before a deal is publicly announced, the price of the company’s stock will mostly like increase, which negatively affects the buyer and reflects poorly on the company’s board.
How is stakebuilding regulated?
Under US securities law, the SEC regulates stakebuilding in public companies. Disclosure requirements are imposed based on the amount of ownership. For example, any person or group that controls more than a 5% beneficial ownership interest in a public company is subject to additional disclosure requirements with the SEC. Under the Securities Exchange Act, if an acquirer exceeds 10% of share ownership in a public company, any subsequent acquisition will be subject to additional disclosure requirements.
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