This article appears in the August issue of our International Corporate Structures Newsletter.
My first experience of legal due diligence was for a Franco-German electrical group, which was buying a UK company. I remember my colleague Bryan patiently explaining what due diligence was (what a strange expression for it!). It seemed a truly herculean task to read all the legal documents involved, let alone write about them. Tax and financial matters were a complete mystery to me – “something for the accountants”. And hopefully the clients knew what they were doing, why they were buying the company, and what they were going to do with it … because I certainly had no clue.
A few years later, I moved to KPMG and started working in multi-disciplinary teams on restructuring projects for large corporates. My experiences in this environment prompted a dawning realisation of how the different aspects of due diligence investigations might fit together, and it all seemed a little less mysterious.
And of course it’s really just common sense: unless the leadership of an organisation believes in gambling as a business strategy, due diligence investigations are a key step before any group reorganisation or corporate transaction. It’s nothing more than an expression of the old adage “look before you leap”.
In most cases, the method for handling due diligence seems obvious – decide which disciplines are relevant (e.g. legal, tax, commercial, HR), ask each function to investigate and report on issues, and then decide whether and how to proceed. Most of the time, this seems to work fine. However, the apparent obviousness of this approach masks a considerable amount of complexity and subjectivity. The due diligence team may be working on the basis of assumptions which are not correct. Apparently insignificant facts which are uncovered by one part of the team may have very material consequences for other disciplines. And different individuals bring different experiences and may have very different views about what’s important.
Often, this complexity may only come to light if the organisation is involved in repeated due diligence, such as in a large-scale legal entity reduction programme, or in a series of acquisitions. This is because the due diligence team may not otherwise receive feedback from the actual operation of the new structure, and therefore the organisation as a whole may not learn from its mistakes.
It is almost inconceivable that the business environment will become simpler over time, and almost inevitable that the complexity of regulation will increase rather than decrease. In light of that, here are five suggested principles or keys for effective due diligence.
- Start with the end in mind: create a brief description of the purpose of the project, and the likely end result in the medium term. For example: not just the removal of a legal entity, but the likely long-term destination structure for the group; not just the acquisition of a business, but the high level approach for integrating it and creating value from it.
- Identify and involve all stakeholders and functional teams. Ensure regular communication between stakeholders and functional team leads.
- Decide and communicate a materiality threshold: a monetary value for the impact of issues which will be considered material. Not every impact can be directly translated into money, but at least it provides a yardstick.
- Decide and communicate any key parameters: such as deadlines, or structures or counterparties which are not to be impacted without consent.
- Ensure that the due diligence requests and due diligence reports prepared by each function are read by the same person or people. This is the only way to identify potential mismatches in assumptions, or the potential relevance of facts identified by one functional team to the analysis carried out by another.
LCN Legal publishes various free resources to help with project planning and due diligence. Click here for more information.