Due diligence in acquiring a business

Purchasing a business is a complex and important decision that requires careful consideration of many factors. Before making an offer and closing the transaction, it is essential to perform due diligence to ensure that the business is a good fit and will provide a solid return on investment.

Due diligence is the stage that comes after the buyer has determined its business needs, identified the type of business it wants to purchase vis-à-vis its long term goals, and the particular target company to acquire or invest in.

The due diligence process involves verifying the financial records, assessing the assets and liabilities, checking for any legal or regulatory issues, and reviewing the contracts and agreements of the business. This usually involves two aspects, consisting of Legal Due Diligence and Financial Due Diligence.

In conducting the due diligence work, lawyers will work together with auditors and, in case the business to be acquired operates in several jurisdictions such as outside of the Philippines, it is normal to work with foreign counsels in a collaborative effort.

Understanding the process of due diligence is important to both the buyers and sellers. For sellers who are looking for buyers or investors, it would be able helpful to understand the process and what documents to prepare. For buyers, it would also be helpful to have an understanding of what documents and information the lawyers and auditors will be looking for to evaluate and conduct their due diligence.

Below is the usual list of documents and information that will be requested in the performance of the due diligence.

1. Company information

a. Certificate of incorporation, articles of incorporation, by laws (from the original to all the amendments) or, business registration with the Department of Trade and Industry for sole proprietors

b. General information sheets and any amendments for the last three years

c. Stock and transfer book with the proper entries

d. Stock certificate book

e. Copies of stock certificates that have been cancelled and those that are currently issued and outstanding showing the front and back pages

f. Proofs of payment of stock transfers previously made such as the capital gains tax and documentary stamp tax returns & the certificate authorizing registration issued by the Bureau of Internal Revenue (BIR)

g. Copies of minutes of the meetings, board resolutions, secretary’s certificates issued by the company

h. Proxies and voting rights issued or executed by stockholders

i. Trust agreements by stockholders

j. Stockholders agreements

k. Monitoring sheet from the SEC to determine penalties and non-submissions

2. Financial information

a. Audited financial statements for the last three to five years

b. Bank information disclosing bank accounts maintained by the company

c. Bank certificates showing outstanding balances

d. Schedule of cash flow, expenses, debt & profitability

e. Disclosure of existing loans and loan documents

f. Schedule of collectibles and receivables

g. Schedule of accounts payables

h. Disclosure of related party transactions

i. List of suppliers and clients/ customers

3. Other financial documents and information

a. Research of the industry and competition including market trends and growth opportunities

b. Disclosure of any existing or potential market barriers

c. Disclosure of the company’s market share and potential for growth

d. Company’s debt levels, credit worthiness and other financial metrics

e. Disclosure of the company’s internal controls, accounting policies and financial reporting processes

f. Information on the company’s risk management practices, insurance coverage, and other potential liabilities

4. Assets to be sold together with the business

a. Property, plant and equipment that are used in the business

b. Property and assets that are held as investment

c. List of any intellectual property owned by the company such as trademarks, patents, copyrights and licenses

d. Appraisal reports on property, plant and equipment whether they be business or investment assets

e. Any claims and potential contingent liabilities involving the assets

f. Copies of ownership and title documents to the assets owned by the company

5. Operations and management

a. List of the current management and key personnel of the business and an assessment as to whether these key people will continue to stay on after the change of ownership

b. Assessment of the company’s technology, operations, and supply chain

c. Copies of contracts and agreements

d. Lease contracts or ownership documents over office space or work sites

6. Regulatory and compliance

a. Licenses and permits such as business permits and registrations with the BIR

b. Registration documents with the Social Security System, Philippine Health Insurance System and the Home Development Mutual Fund and copies of remittances made as well as clearances from the agencies

c. Copies of secondary licenses, authorities and permits which are specific to particular industries where the business operates such as those from the Bangko Sentral ng Pilipinas, Securities and Exchange Commission, Technical Education and Skills Development Authority, and the like

d. Tax compliances such as filed tax returns

e. A list of open cases issued by the BIR

f. Registration with the National Privacy Commission for covered entities

g. Registration with the Anti Money Laundering Commission for covered industries

h. Compliance with environmental and other laws, rules and regulations that may be applicable to the specific industry where the business is operating

7. Legal matters and ongoing litigation/cases

a. Analysis and evaluation of pending lawsuits with an evaluation of the cases and possible contingent liability

b. Disclosure of ongoing tax audits by the BIR and their status

c. Disclosure of any potential labor disputes and union issues

d. Disclosure and review of ongoing, expected or threatened government investigations

e. Examination of any intellectual property or licensing agreements

f. Copies of all existing contracts and legal obligations

8. Human resources

a. Review of current staffing levels and a list of employees, their compensation packages, and other benefits

b. Labor and employee contracts

c. Department of Labor and Employment inspection and other reports

d. Employee manual and the company handbook, and rules and regulations

e. Summary of labor and employee administrative disputes and disciplinary proceedings

f. Employee evaluations

9. Information Technology

a. Disclosure of the company’s technology infrastructure and systems

b. Company data security policies and procedures

c. Evaluation of any existing or potential technology liabilities

It is worthwhile to point out that there are businesses that are hesitant to let their employees know that there may be a change in ownership. We usually advise buyers to discuss with the sellers that it may be necessary to inform some key people of the planned transaction as there will be a need for disclosure of documents and information, without which they  may not be able to properly conduct its due diligence. Moreover, there may be a need to interview some key personnel.

Obviously, the list is long and the process may be tedious. Some documents and information are more important and essential than others. In our next articles, we shall discuss some salient points specific to the requirements.

(The author, Atty. John Philip C. Siao, is a practicing lawyer and founding Partner of Tiongco Siao Bello & Associates Law Offices, teaches law at the MLQU School of Law, and an Arbitrator of the Construction Industry Arbitration Commission of the Philippines. He may be contacted at [email protected]. The views expressed in this article belong to the author alone.)