If you are buying a business, due diligence is your opportunity to look under the hood before you commit.<\/p>\n\n\n\n
If you are selling, it is the buyer’s opportunity to do exactly that, which means you should ideally have looked under the hood yourself first.<\/p>\n\n\n\n
Due diligence can seem overwhelming, particularly when the first request for documents arrives with dozens (sometimes hundreds) of items. But the basic objective is fairly simple: understand the business, confirm what has been represented and identify problems before closing.<\/p>\n\n\n\n
Here are some of the main areas Quebec entrepreneurs should expect to deal with.<\/p>\n\n\n\n
1. Corporate Records<\/strong><\/p>\n\n\n\n Let’s start with the corporation itself.<\/p>\n\n\n\n The buyer will normally want to confirm that the corporation has been properly maintained and that its records reflect what everyone says they do.<\/p>\n\n\n\n This usually means reviewing:<\/p>\n\n\n\n A practical tip for sellers:<\/strong> have your minute book reviewed before the buyer gets access to it.<\/p>\n\n\n\n Missing resolutions, outdated registers and transactions that were never properly documented are quite common, particularly with older privately held businesses. Most can be fixed<\/a>. It is simply much better to deal with them before the buyer’s lawyer raises them.<\/p>\n\n\n\n 2. Who Actually Owns the Business?<\/strong><\/p>\n\n\n\n This may sound obvious, but it is something that needs to be confirmed.<\/p>\n\n\n\n Who are the shareholders? What percentage does each person own? Are there different classes of shares? Does anyone have an option or other right to acquire shares?<\/p>\n\n\n\n The review may also cover shareholder loans, restrictions on transfers, rights of first refusal and any pledges affecting the shares.<\/p>\n\n\n\n If there are informal arrangements between shareholders that were never properly documented, this is the time to identify them, not three days before closing.<\/p>\n\n\n\n This is particularly important in a share sale, where the buyer is acquiring ownership of the corporation itself.<\/p>\n\n\n\n 3. Material Contracts<\/strong><\/p>\n\n\n\n Most businesses depend on a relatively small number of important contracts.<\/p>\n\n\n\n Think major customers, suppliers, distributors, landlords, lenders, equipment lessors, franchise agreements and other long-term arrangements.<\/p>\n\n\n\n The buyer will want to review those agreements, but not simply to confirm that they exist.<\/p>\n\n\n\n One of the important questions is: what happens to these contracts when the business is sold?<\/strong><\/p>\n\n\n\n Some agreements can be assigned freely. Others require consent. Some contain change-of-control provisions that may be triggered by a sale of the shares.<\/p>\n\n\n\n You don’t want to discover a week before closing that your largest customer, landlord or lender needs to approve the transaction.<\/p>\n\n\n\n 4. Employees<\/strong><\/p>\n\n\n\n For many businesses, the employees are as important as the physical assets, sometimes considerably more important.<\/p>\n\n\n\n Expect questions regarding:<\/p>\n\n\n\n The treatment of employees can also differ significantly depending on whether the transaction is structured as a share purchase or an asset purchase.<\/p>\n\n\n\n If a few key people are essential to the value of the business, that should be identified early.<\/p>\n\n\n\n 5. Financial Information and Debt<\/strong><\/p>\n\n\n\n Your accountant will usually take the lead on the financial side of due diligence, but the financial and legal reviews often overlap.<\/p>\n\n\n\n The buyer will typically want to understand the company’s financial statements, bank debt, lines of credit, shareholder loans, equipment financing, accounts receivable and payable, capital expenditures and working capital.<\/p>\n\n\n\n This information can have a direct impact on what the buyer ultimately pays.<\/p>\n\n\n\n For example, many business acquisitions are negotiated on a cash-free, debt-free basis<\/a><\/strong>, with an agreed level of working capital to be delivered at closing.<\/p>\n\n\n\n That sounds straightforward until the parties have to decide exactly what counts as \u201cdebt,\u201d \u201ccash\u201d and \u201cworking capital.\u201d<\/p>\n\n\n\n Those definitions matter.<\/p>\n\n\n\n 6. Taxes<\/strong><\/p>\n\n\n\n Nobody wants a tax surprise after buying a company.<\/p>\n\n\n\n Tax due diligence may involve reviewing corporate income tax filings, GST\/QST matters, payroll deductions, notices of assessment, tax audits, outstanding balances and previous corporate reorganizations.<\/p>\n\n\n\n This is an area where the company’s accountants and tax advisers should be involved.<\/p>\n\n\n\n\n
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