Due Diligence in the Purchase or Sale of a Maryland Business

The term “Due Diligence” refers to a process by which someone contemplating the purchase of  a business investigates that business in connection with the anticipated transaction. The seller in the transaction also may engage in some amount of seller-side due diligence when a sale is contemplated, though the seller’s efforts are typically far more limited than the buyer’s efforts, since the seller already has detailed knowledge about the finances and operations of its own company.  The potential buyer’s due diligence efforts often are coordinated by an attorney representing the buyer, but it is common and advisable for the buyer to form a team of accountants, managers, consultants and sometimes outside experts, to participate with the attorney in the due diligence process.  The scope of due diligence is dependent on the particular company and situation, but the goal must be to gather enough information about the acquisition target to make informed decisions about the contemplated transaction.

Due diligence is intended to identify problems with an acquisition target and the risks associated with going through with a transaction, but should also involve evaluation of the positive attributes of a contemplated transaction.  If the acquiring company is interested in purchasing another company in order to fit a particular need or enter a new business area, then one area of due diligence should be to focus on whether the contemplated addition meets this need, and to what degree the desired outcome will be achieved by the transaction.

Comprehensively discussing all aspects of due diligence would fill an entire book, and this article is not intended to cover all aspects of an adequate due diligence process. Questions of scope and depth of due diligence depend on the particular transaction, on the nature of the seller’s operations and financial condition, and on the contemplated transaction terms. A central consideration in determining the extent of due diligence is thinking through the allocation of risk between buyer and seller. Both sides of a transaction will weigh the amount of risk each is willing to take, and a number of things will go into that assessment, including the sale price and the nature and strength of representations and warranties that will be included in the transaction documents.  For example, a buyer might insist on a lower purchase price – all things considered – if its opportunity to conduct thorough due diligence is limited, and may be willing to pay more for a company if it is able to thoroughly conduct extensive due diligence.  Likewise, the negotiated sale price may depend, in part, on whether the buyer receives strong and extensive contractual representations and warranties in the purchase contract. The converse also is true, from the seller’s perspective.

The nature of due diligence in a particular transaction is also strongly influenced by whether the deal is structured to be an asset sale, stock sale, merger, or sale of LLC member interests. The scope also depends upon whether the transaction is structured to have all due diligence completed prior to the parties signing the transaction documents with a simultaneous closing of the transaction, or to have the transaction documents signed first, followed by continued due diligence prior to closing to verify the accuracy of representations and the satisfaction of conditions for closing.

In the course of conducting due diligence, the buyer side of the transaction typically will issue an often-lengthy list of documents and data that it wishes to review, and also will seek access to the seller’s management, accountants, and perhaps key third parties.  The produced documents and data are reviewed by the buyer’s due diligence team, which under almost all circumstance should contain buyer representatives in the areas of legal, accounting, and business operations.  Within the legal area, often a senior attorney in a law firm representing the buyer will organize and coordinate the due diligence efforts, with less-senior attorneys and/or paralegals in the law firm doing much of the legal work. A similar allocation of workload also is often used with outside accounting firms representing the buyer for the accounting aspects of the due diligence review.

Purchasing or selling a business is not a simple process, even when the buyer and seller are relatively small companies.  Acquiring a $1 million company is far less complicated than acquiring a $100 million company, of course, but I am sometimes surprised when the contemplated buyer or seller of a small- or mid-size company discusses a potential acquisition with me and has an expectation that its attorney can quickly read through a few documents and thereby adequately cover all the bases.  In fact, even the simplest acquisitions of small companies require a significant amount of legal and accounting work. Having said this, there can be wide variations in cost depending on many factors, including the size and complexity of the acquisition target, the transaction terms, and selection of the right law firm to thoroughly perform all legal work necessary in an acquisition while still keeping costs manageable.

If you are contemplating the purchase or sale of a Maryland business, whether through asset sale, stock sale, or transfer of limited liability company member interests, our firm has the background and skills necessary to guide you through this process.  Please contact Lewicky, O’Connor, Hunt & Meiser at (410) 489-1996 or [email protected].