What’s the Difference between Legal and Financial Due Diligence?3 Oct 2019
For any firm considering buying a business or selling their own, it’s essential to carry out due diligence to determine if there are any potential risks with the transaction. Due diligence is the process undertaken by a prospective buyer of a business to identify any potential liabilities and to assess its commercial potential. It is undertaken across both the legal and financial aspects of the transaction and is an essential first step in the process.
Traditionally, legal and financial due diligence is conducted by two separate firms: a company’s accountant and a company’s solicitor. Except where a company engages an ABS to do the work. An ABS is an alternative business structure that is regulated by the Solicitors Regulation Authority which allows both solicitors and accountants to work in the same firm so that these two services can now be combined – to the benefit of business owners.
Why combine the two?
- Time saving –If you already have an accountant in place they with be aware of all the financial aspects of your business. They might then help you search for a law firm that specialises in buying and selling businesses, this takes time and they will then need to bring the law firm up to speed on the business and its objectives.
- Efficiency – Combining financial and legal services into one firm allows for easy sharing of essential information, ensuring consistency to the due diligence process.
- Comprehensive perspectives – a firm that offers both can analyse the best moves for the business with insights into both legal and financial standpoints – potentially avoiding expensive mistakes before the due diligence process even begins.
What’s the difference?
For business owners, it’s still important to understand the distinctions between legal and financial due diligence as both play a vital role in the process of buying or selling a business:
Financial due diligence
A financial due diligence review aims to determine whether the forecasts provided reflect a true representation of the other company’s performance. The process aims to:
- Establish an agreeable, fair purchase price
- Review historical records, current financial data and forecasts
- Investigate any significant trends in historical results
- Assess historical earnings for reliability and sustainability
- Establish realistic potential future earnings
- Consider any tax consequences based on forecasts
From there, the necessity for any warranties or guarantees in any sale agreement can be assessed, and whether there are any potential issues such as large tax liabilities, outstanding debts or impending financial penalties. These issues may not break the deal, but they could create the need for further negotiation.
Legal due diligence
To gain an overall picture of the company’s operations and the value (or liabilities) it could add to your business, it is imperative to carry out legal due diligence.
Solicitors will research and analyse the potential legal implications of the following:
- The structure of the business
- Ongoing contracts and their transferability
- Employment policies
- Intellectual property or data that belongs to the business
- Regulatory compliance requirements
- Environmental and health and safety record and policies
- Data protection and privacy
- Outstanding litigation issues
- Ownership of property along with any other assets.
Uncovering factors such as complications with transferring existing contracts or outstanding litigation issues is essential to ensuring that you head into a purchase or sale fully informed, sufficiently protected and with a fair purchase price agreed.
At Accounts and Legal, we know that decisions surrounding buying and selling a business can be complex. We believe strongly that combining financial and legal expertise puts our clients at a distinct advantage. Sharing and analysing cross-referenced data in-house allows us to provide an informed perspective to support our clients in their most important professional decisions. Despite this, it’s still important for business owners to understand the two to ensure the process of buying or selling a business runs smoothly.
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