Mark Pestronk
Q: A prospective buyer of my agency says that he wants to conduct "due diligence" before sending me a purchase agreement. What does that term mean? Is it really necessary for the buyer to do this, and if so, why? When is the best time to conduct it? How do I protect my confidential information in the process?
A: The odd-sounding term means a buyer's investigation and review of aspects of the seller's business, using information and documents provided by a prospective seller. The purpose of due diligence is to help the buyer decide whether to proceed with the acquisition and, if so, whether any previously offered terms need to be changed.
The phrase comes from the 1933 federal law governing stockbrokers, who must investigate companies whose stocks they recommend. Buyers of companies adopted the phrase and applied it to all companies that they want to buy.
A buyer's investigation can be as simple as orally asking a few questions or as complicated as a 100-plus list of questions for which you must provide answers and supporting documents. Generally, the larger the prospect, the more extensive the process, especially if the buyer is backed by investors such as private-equity firms.
Typical due diligence questions are a request for copies of all contracts and leases as well as a summary of any oral contracts. Another example is a list of all employees, with compensation, title and seniority for each.
Nearly all acquisitions involve some due diligence, but some do not. An example of the latter would be absorption of the business of an agency that is in the process of closing and needs to be acquired practically overnight in order to preserve the business.
Generally, the buyer gets to decide when, in the acquisition process, due diligence will be conducted, and you need to respond fairly quickly. Typically, the buyer would require your responses after a letter of intent has been signed, but sometimes the parties wait until after the agreement has been signed but before the closing.
To protect the confidentiality of your agency's information, there are a few steps you can take. First, before you disclose anything that is not public information, make sure that the prospective buyer signs a confidentiality or nondisclosure agreement.
Second, you can try to break the process into stages or rounds of disclosure. Before an agreement is signed, you can disclose less-sensitive information, and you can identify employees and clients by code numbers instead of names, for example.
One always-confusing and frustrating issue is why the agreement appears to require that you disclose the same information that you previously and separately disclosed as part of the due diligence process. For example, although you produced copies of all your contracts, you still are required to list them in an exhibit to the agreement.
Buyers see the duplication as necessary because each step is for a different purpose: Due diligence is to help the buyer learn more about your business, while exhibits to the agreement are needed because the seller is promising that the facts about your agency are as stated in the exhibits.
You do not need a lawyer, accountant or other outsider to respond to due diligence requests, unless you have questions or concerns about what should be disclosed.