When selling a car, the owner will generously take every advantage of the vehicle into account when setting the price. The potential buyer, on the other hand, will try to find a fly in the ointment. While buyer and seller circle the car and point out its pros and cons, they arrive at a valuation of the vehicle. The sale price will likely end up somewhere between the expectations of the two parties.
Similar to looking for scratches or beautiful seats in a car, the process of business valuation or a due diligence review works when a company changes hands. The due diligence process, however, is significantly more complex and the price involved much higher. Yet the sale of a car and that of a company have an interesting dynamic in common: The seller focuses on price-increasing factors, the buyer on price-reducing factors.
What does due diligence mean?
Due diligence is an essential concept in Swiss law and refers to the “due care required in commerce”. This thorough review is crucial for analysing companies or individuals in terms of their economic, legal, tax and financial aspects.
At its core, due diligence aims to identify potential risks and opportunities associated with a business transaction or investment. Various aspects such as corporate structure, market position, assets, liabilities and compliance practices are examined. This detailed investigation enables investors and business partners to make informed decisions and minimise the risk of unexpected issues.
To carry out due diligence, the buyer usually engages specialists and external advisors. The advisors obtain the necessary information from company documents and data as well as from discussions with the company’s management.
Why do companies need a due diligence review?
The due diligence review is of critical importance for companies in order to make well-founded decisions in business transactions, especially in the context of mergers and acquisitions. This comprehensive analysis covers various risk areas and ensures that companies can achieve their objectives without facing unexpected challenges.
1. Legal protection: A key aspect of due diligence is the legal review. Companies must ensure that they and their partners comply with all relevant laws and regulations. This includes checks for compliance with anti-money laundering regulations, anti-corruption rules and sanctions regimes. Thorough legal due diligence protects against legal consequences and ensures that all business activities are in line with the law.
2. Financial stability: Financial due diligence focuses on a company’s financial health and stability. It helps to uncover potential financial risks such as hidden debts or questionable accounting practices. Careful financial analysis is crucial to avoid unexpected costs and safeguard the profitability of the investment.
3. Protection of reputation: Companies must also assess reputational risks. Working with business partners involved in illegal or unethical activities can have serious consequences for their own image. Due diligence helps identify and avoid such risks in order to maintain a good reputation and the trust of stakeholders.
4. Economic synergies and risks: In the economic sphere, due diligence aims to assess a company’s actual performance and potential. It includes an analysis of market position, competitiveness and potential synergies in mergers or acquisitions. This step is crucial for ensuring the long-term profitability and growth potential of the business transaction.
By taking these four key areas into account, the due diligence review enables companies to make informed, risk-aware decisions. It is an indispensable tool for ensuring the long-term stability and success of business activities.
How is a due diligence review carried out?
Carrying out a due diligence review is a structured and detailed process divided into several phases. The goal is to gain a comprehensive understanding of the legal, financial and operational aspects of a contracting party in order to make informed business decisions. Here are the steps that characterise an effective due diligence review:
1. Planning: The process begins with careful planning, which includes identifying the contracting party and defining the scope of the review. The necessary resources are determined to ensure an efficient review.
2. Information gathering: In the next step, relevant information is collected. This includes financial information, business reports and legal documents to gain a detailed picture of the contracting party.
3. Screening: The collected information is checked against global sanctions lists and watchlists as well as blacklists. In addition, beneficial ownership is reviewed and, as part of the PEP (Politically Exposed Persons) review, political connections are analysed.
4. Analysis & risk assessment: Based on the information, an in-depth analysis is carried out to identify strengths, weaknesses and potential risks. This phase is crucial for assessing the integrity and value of the contracting party.
5. Documentation: The results of the due diligence review are summarised in a due diligence report. This serves as evidence of the review and compiles all key findings.
6. Monitoring: Finally, continuous monitoring is established. This ensures compliance with the defined requirements and that identified weaknesses are rectified.
Thorough due diligence is essential for risk management and creates a solid foundation for successful business transactions. It helps create transparency and minimise business risks.
Benefits of due diligence
Conducting due diligence primarily makes the purchase decision easier for the interested party, as all information about the company’s opportunities and risks is now on the table. The seller also knows the appropriate price for their company after due diligence.
Benefits for the buyer of a company:
In the context of succession planning within a family, due diligence is often waived. However, if an external person takes over the company, a careful review is recommended. After all, the potential buyer wants to form their own opinion of the company’s position in the market, its market share and competitive environment. They also need an overview of all relevant legal and tax aspects.
Benefits for the seller of a company:
Due diligence brings advantages not only for the buyer but also for the person handing over the company. With due diligence, the sale of a company proceeds ** more efficiently and rationally. In addition, the structure of the transfer is optimised for the seller from a tax perspective. The potential successor who wishes to take over the company must take into account the information disclosed by the due diligence. This reduces the seller’s liability risk. Nevertheless, the contractual agreements remain reserved.
Scope of due diligence
The planned form of transfer of the company has the greatest impact on the scope of due diligence. Depending on whether only individual parts of the company, such as patents or operating equipment, are taken over or the entire company changes owners, different forms of review are required.
- Asset deal: In this type of business acquisition, only specific assets of a company are taken over. Therefore, only those assets designated for acquisition are subjected to in-depth review. These assets include, for example, operating equipment, inventories or patents.
- Share deal: In this case, the acquisition of the entire company is intended. Therefore, all assets, obligations and general risks of a company must be reviewed. Due diligence thus also covers all assets and liabilities, for example for the last three financial years.
How long does due diligence take?
Regardless of the scope of the transfer, it is crucial that both parties allow sufficient time for the review. Only then can thorough due diligence be achieved. The duration of such a careful review is largely influenced by the size of the company. In the case of due diligence for a larger company, several specialists may examine the opportunities and risks on behalf of the buyer. It must also be taken into account that certain documents still need to be obtained or prepared by the transferor.
How high are the costs of due diligence?
Time and therefore money can be saved if the seller compiles the relevant documents at an early stage. This compilation is usually carried out using a checklist. In a so-called data room, the buyer’s advisors are given access to the information and documents. During the review, the potential buyer may request further documents in order to gain a more detailed insight.
What is examined in due diligence?
As a rule, due diligence relates to various sub-areas. Each company puts together the topics individually.
- Financial due diligence: A central component of a business transfer is the analysis of the company’s current financial situation and its planned financial development. In financial due diligence, the drivers of the business are identified, the value chain is analysed and the necessary purchase price adjustments are calculated.
- Legal due diligence: As the acquisition of a company is often lengthy and complex, it is important to protect yourself against legal risks. Legal due diligence is intended to prevent legal disputes between the two parties and, among other things, to review ownership structures, supplier contracts and social obligations.
- Tax due diligence: The tax situation of the company for sale is examined through tax due diligence. This area analyses which transfer taxes may arise in a business acquisition. Tax returns, annual financial statements and tax loss carryforwards are also in focus.
- Commercial due diligence: As part of commercial due diligence, the market, customer and competitive situation is reviewed. In addition to the current situation, this area also includes an assessment of the opportunities and risks of the business model and its future viability.
- Operational due diligence: This sub-area deals with the analysis and optimisation of production processes and highlights development potential in logistics, sales, procurement, production as well as research and development.
- Technology due diligence: IT due diligence examines the efficiency and effectiveness of operational processes in the company’s information technology (IT). Among other things, it analyses which systems are in place in the IT area, what costs arise at the IT interfaces and whether there is a digitalisation strategy for the company.
- Human resources due diligence: This area focuses on employee-related figures such as staff turnover. Human resources due diligence also includes an analysis of employment contracts and pension fund obligations.
The majority of due diligence should be carried out before the business purchase agreement is signed. Individual sub-aspects are occasionally analysed after the contract has been concluded. Further areas in which due diligence may be carried out include environment, compliance, real estate and insurance.