News
Vendor due diligence - an increasing trend in Australasian M&A
First published in The Independent Financial Review, 4 April 2007.
Why would a company invest time and money conducting due diligence on a business it plans to sell, even when it has had years of ownership to get to know the operation?
It may seem counter-intuitive but many are now electing to do just that. Across Australasia, vendor due diligence is becoming an increasingly common feature of M&A transactions, and New Zealand based transactions are no exception.
With competitive sales processes on the rise, it is now almost an expected part of the sales package.
What is vendor due diligence and what are its benefits for a vendor?
Vendor due diligence is a process by which the vendor, itself and through its advisers, undertakes a systematic review of the business it is proposing to sell. In addition to the commercial aspects, including the obvious issue of identifying what is for sale, the review generally covers the legal and financial aspects of the business and may include a review of environmental issues. The aim is to provide an orderly collation of all material information relevant to the sale business.
The extent of the process will vary depending on what the information will be used for. It is important to determine at the outset whether the due diligence outcomes are simply for the eyes of the vendor or may also be viewed and, as a next step, relied on by potential purchasers.
Many of the high profile competitive sales processes that have occurred in the last 18 months have included vendor due diligence. In almost all cases, some degree of reliance on the due diligence findings has been made available to the purchaser.
From a vendor's perspective, a full due diligence prior to entering into discussions with potential buyers can be very helpful. A full review should identify:
- Giving bidders an orderly set of information that can act as a road map through any data room disclosure material, assisting them to determine their priorities.
- Reducing the time bidders need for any due diligence review they may wish to undertake themselves.
- Reducing the disruption to the vendor otherwise created by having multiple bidders trawling through the same issues one by one.
Vendor due diligence can also be used to great benefit for both parties in relation to regulatory consents. For example, in a transaction involving considerable land interests, relevant due diligence information on the land can be provided to the Overseas Investment Office and to bidders at the start of the sales process. This means that the OIO analysis can already be underway prior to bidders providing the buyer-specific information, potentially reducing timeframes considerably.
Potential pitfalls
But there are some significant potential pitfalls that both vendors and purchasers should bear in mind, particularly regarding purchaser reliance on vendor due diligence.
It will be critical to clearly determine exactly the extent to which a purchaser may rely on a vendor due diligence report. It must be clear whether disclosure of the report is on an information only but no reliance basis, or if the purchaser can rely partially or fully on the information.
The vendor's advisers will be concerned to avoid possible conflicts of interest issues and undue potential professional liability issues. Practically, for a vendor, this means that some attention is required at the outset to the terms on which advisers are engaged. In addition to agreeing a clear scope for the due diligence with their advisers, including materiality thresholds and the nature of the report, vendors will also need to agree the extent to which others, such as bidders or financiers of bidders, may rely on the advisers' reports.
Advisers will also be concerned to ensure their report, if relied on by a purchaser or financier, is limited to factual matters and qualified by the parameters of the review and the assumptions made. Advisers may also seek to cap their liability to a certain value.
These aspects translate to a number of possible limitations that should be understood and factored into the use of a vendor due diligence report. Questions to be considered by both vendor and purchaser include:
- What limitations apply to the scope of vendor due diligence? For a purchaser, does it cover everything they need to know? Was the review undertaken to the same level of materiality that the purchaser requires?
- Did the advisers themselves check the accuracy of information provided to them for the purposes of their review, or was that simply assumed? Can a purchaser adequately protect against any assumption of accuracy through a vendor warranty, or should the purchaser attempt to verify this itself?
- How current is the report? Does it need updating?
- What limits have been placed by the relevant adviser on purchaser reliance on the report? What limits exist with respect to any vendor representations in respect of the report or its contents?
- Are there any liability caps?
A vendor may also seek to pass some of the costs of a vendor due diligence - at least to the successful purchaser.
In the current climate, it seems vendor due diligence is likely to continue to play a role in M&A transactions. With careful management and an awareness of potential risks or limitations on the part of both the vendor and the purchaser, that should be to everyone’s benefit.
