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The importance of Due Diligence in corporate and real estate business

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The importance of Due Diligence in corporate and real estate business.

 

I – The Concept

A Legal Audit, also known as Due diligence, can be defined as a set of legal procedures aimed at obtaining, analyzing and verifying information and legal documents (in the sense of containing legal rights and duties).
Due Diligence (and here we are talking about legal Due Diligence, which is important to distinguish from financial Due Diligence, which comprises the analysis of financial and accounting information) usually occurs in the planning or monitoring phase of a negotiation for the purpose of acquiring rights (for example acquisition of a shareholding in a company, or acquisition of real estate). And it aims to answer an essential question: what is really being purchased?

II – Care to be taken when preparing and carrying out Due Diligence
There are several precautions to be taken when preparing and carrying out Due Diligence, which can be extended to
all parties (sellers or buyers), of which we highlight:
  • Respect for confidentiality rules – From the moment a demonstration of interest is presented (for example Letter of Interest) and it is validated by the selling entity, the information circulated within the scope of Due Diligence is often sensitive and confidential information. Everyone who will have access to this information must be identified and be prepared to sign confidentiality documents (NDA's) that reflect the conditions of the respective intervention.

 

  • Protection of personal data – Increasingly, national and community legislation requires compliance with various legal requirements regarding documents and databases that contain personal information.

 

  • Cross-reference the information with the Financial Audit (Financial Due Diligence) – It is often the case that, in parallel to legal Due Diligence, financial Due Diligence is being developed. The patrimonial reality, the set of rights and duties (I understand the recognition of payments, debts, credits, employment contracts, insurance contracts, etc.) however, is only one and will have to be reflected in both Due Diligence. It is therefore important that the information resulting from these two audits is shared between those responsible for each area, not only for the purposes of preparing the acquisition but also for the purposes of preparing the company's activity after the acquisition (for example, in order to identify the needs capitalization of the company in specific matters by the new owners).

 

  • Observance of third party rights – It is important to ensure that the documents and information on which the Due Diligence analysis will be carried out may include the rights of third parties or rights prior to any negotiation. A mortgage creditor, for example, has a right (embodied in a debt in his favor) that directly affects the equity value of each asset.

 

III – Advantages of Due Diligence:

In practical terms, there are several advantages to carrying out Due Diligence, whether it is an acquisition of a shareholding or a real estate asset.

  • Knowledge of the real and financial risks of each operation or each asset – First of all, Due Diligence allows us to better understand the real risks involved. A company that has several processes under litigation will necessarily have to have its value assessed taking into account the risk in question. A company that is not complying with its licensing obligations will also have to have its value assessed taking into account the risk in question. A company that does not have up-to-date land or industrial property registrations (trademarks, patents, etc.), or that are in the process of being cancelled/terminated, will also have to have its value assessed taking into account the risk in question. And these are just a few examples. At the end of the day, what is worth money is only what is registered, or what is protected in documents (for example contracts). The identification of the real and financial risks of each operation or each asset must always be prior to the acquisition.

 

  • Improve the negotiating position – Directly associated with the identification of risks comes negotiation. Many negotiation solutions are possible but only if the risks are known. For example, making the payment of part of the price conditional on the favorable resolution of litigation processes. Or simply, lowering the acquisition price.

 

  • Support decision making according to rational criteria – Given the uncertainty in the business world, it is relatively common to see pressure to hold directors of companies responsible for taking a certain
    decision to acquire a shareholding or real estate asset that may not result in asset appreciation. From this perspective, a Due Diligence report not only clarifies in advance which criteria
    that were verified and followed (and their respective support) to arrive at a certain assessment, as it immediately eliminates the liability of an administrator for negligence. In practical terms, an administrator in light of legislation
    currently in force – See article 72, no. 1 of the Commercial Companies Code – you can never be held responsible for negligence in a business of the company you manage, if you have made your decision following rational criteria in the interests of the company.
    company and embodied in a Due Diligence report.

 

  • Prepare acquisition financing more rigorously – Assuming that the desire to acquire remains after carrying out Due Diligence, it is important to start preparing the financing of the acquisition taking into account the information gathered. It may, for example, be in the buyer's interest to establish that the price will be paid at different times, or conditioned on certain results or objectives. It is also important to consider preparing the future of the company's activity after the acquisition itself. Where is greater financial caution or greater investment justified?

 

  • Asset optimization and identification of new markets – Several of the legal documents that are submitted for Due Diligence analysis allow us to identify points where there is waste in a company's activity, or at least, where the company's activity could gain new customers and even new markets. For example, when analyzing contracts and partnership agreements.

 

* This article is for informational purposes only and does not preclude the need for
advice from a lawyer.