How to deal with due diligence when selling shares
If you are selling shares in a business, the buyer (or their legal team) will have a lot of questions for you. They will ask about issues such as legal liabilities, regulatory compliance and financial liquidity to get a clear picture of exactly what they are buying.
This process is called ‘due diligence’ and, as a seller, you must be very careful about the answers you give. Any mistakes could leave you open to post-sale legal action from the buyer if they later uncover a problem that you should have told them about.
In this article, we cover sellers’ obligations during due diligence, the risks they need to manage, key due diligence areas for share purchases and the steps involved in the process.
Need advice on a share purchase? Please contact Michael Budd who will be happy to advise.
Key points to know about due diligence for share purchases
- Sellers have a duty to act in good faith, respond promptly to enquiries and formally disclose any known issues affecting the business during due diligence
- The seller must provide a legally-binding statement of fact, called a ‘warranty’, affirming they have given a full and honest account
- Any issues uncovered during due diligence could negatively impact the purchase price
- A seller could face civil action from the buyer once the sale is complete if the buyer believes the seller was not completely forthcoming during due diligence
- A pre-sale audit can help to proactively identify potential issues so they can be resolved or factored into the price
- An experienced commercial lawyer can ensure the seller’s due diligence obligations are met, reducing the seller’s risk of post-sale issues
Key due diligence areas for share purchases
Due diligence for share purchases typically covers key areas such as:
- Corporate – Clarifying the business’s legal structure and matters such as its articles of association and shareholders’ agreements.
- Finances – Reviewing the company’s accounts, performance, profitability, tax status and liabilities such as business loans.
- Assets – Confirming exactly what assets the business owns, including real estate and intellectual property.
- Commercial considerations – Determining the status of the business’s commercial contracts and agreements, as well as any other significant commercial issues.
- Employment matters – Assessing employees’ contracts as well as any current or historic employment law issues.
- Legal liabilities – Identifying any outstanding legal issues affecting the business, such as any ongoing litigation or potential litigation.
- Regulatory compliance – Establishing the business’s standing with regulators and any potential compliance issues.
- Data protection – Clarifying what data the company holds, its data protection obligations and processes, and any potential issues.
Step-by-step guide to the due diligence process
The following are key steps in a standard due diligence process for share sales:
- Pre-sale audit – Carried out by the seller to identify any potential issues that could impact the sale price.
- Signing of Non-Disclosure Agreements – Ensuring the buyer cannot share any information disclosed to them during due diligence.
- Buyer queries – The buyer’s legal team will provide a questionnaire covering all the information they require.
- Seller answers to queries – Usually carried out by the seller’s legal representative. All answers must be honest and complete to the best of the seller’s knowledge.
- Seller sets up secure data room – This is an encrypted online space that can only be accessed by the parties to the sale. All relevant documents will be held in this space until the sale is finalised.
- Buyer reviews documents – The buyer’s legal team will review all documents held in the data room, such as the articles of association and shareholders’ agreements.
- Public domain checks – The buyer’s legal team will review information about the business held at Companies House and confirm its ownership or lease agreements for real estate with HM Land Registry.
- Face-to-face meetings with key personnel – Buyers will typically want to meet management and key senior employees in person to discuss potential issues and build relationships.
- Site visits and valuations – Buyers normally ask to visit any business premises and have them independently valued.
- Due diligence report issued – This will be produced by the buyer’s solicitors for their client detailing all issues uncovered.
- Seller’s warranty – The seller must provide a written contractual confirmation that all information provided during due diligence is accurate to the best of their knowledge. The buyer could take legal action for breach of warranty if they later uncover an issue the seller should have known about and disclosed.
- Seller’s disclosure letter – The seller’s solicitors will draft a letter outlining all issues identified during due diligence to protect the seller from any claims for breach of warranty after the sale is complete.
Once these steps are completed, the sale can go ahead.
How Longmores can help with due diligence in share purchases
At Longmores, we regularly help clients with all aspects of share purchases, including due diligence. We can guide you through the entire process, including preparing answers for buyer enquiries. Having our expert support can help due diligence to run smoothly, protect your interests during the sale and minimise the risk of post-sale legal action.
For expert advice on share purchases, please contact Michael Budd who will be happy to advise.
Please note, the contents of this article are given for information only and must not be relied upon. Legal advice should always be sought in relation to specific circumstances.
