The need for a due diligence

due diligenceA due diligence is typically a process during which a potential buyer establishes and quantifies the value of the company (hereinafter: target company) or the assets it intends to buy based on information made available by the seller or other sources, prior to the acquisition.

Why is a due diligence necessary?

Conducting a due diligence is naturally not mandatory in Hungary, and indeed, it can imply a significant cost, but if we neglect to do so this means that we are blindly trusting the other party; which it may sound very philanthropic, but business relationships do not work like this. There is significant information asymmetry between the seller and the buyer because the seller has much more information about the target company than the buyer. Additionally, since significant amounts may depend on this, the seller has an interest in making the reality nicer and better than it actually is, or to gloss over information that is insignificant in itself, but if the buyer were aware of such information, it would find itself in a completely different bargaining position, or would perhaps even withdraw from the transaction.

The possibility of a due diligence generally arises when the seller and the buyer have already conducted one or more negotiations, and they are by and large in agreement with regard to the main framework of the sales transaction, though without any commitments, not including the purchase price and the potential guarantee withholdings and warranties. In this phase, the seller has to understand that sharing the information it has does not violate its business interests, but is rather, the buyer needs to be well informed with a view to closing the deal successfully.

Although the starting point of the evaluation is generally an accounting document such as an annual report, or a general ledger, a well-performed due diligence audit is more than just a simple accounting due diligence. In order for the buyer to make a well-founded decision that serves its interests the best, in addition to an accounting due diligence it is also worth reviewing the company’s legal, environmental, IT or even manufacturing processes.

So a due diligence is a multi-faceted project, and carrying it out professionally requires thorough knowledge of the individual specialist fields. It is advisable to use professionals for this.

What to expect from professionals? 

First and foremost, they need to be prepared in the relevant field, perform thorough work, cooperate with the team auditing another area, and keep the buyer informed on a regular basis, or in the case of a significant finding, immediately. However, this framework has to be specified by the buyer. It is important to indicate the thresholds beyond which the negotiations are terminated automatically, or the sensitive issues, which, if uncovered, result in the termination of the negotiations with the seller, regardless of their size.

A due diligence only leads to the right result if the seller provides all the necessary information. If the professionals do not receive part of the information requested, it is their task to judge what kind of risks the lack of such information may represent for the buyer later on.

The end product of the due diligence should be a due diligence report which, based on the information made available and that not shared, estimates the risks related to the key individual fields, thus helping the buyer’s management in making a thorough and informed decision and in defining an advantageous and rational purchase price.

Take our advice: if a seller is hesitant about or refuses to sanction a due diligence audit, they have a good reason for it, and the buyer should therefore start looking for a different acquisition target.


Due diligence as part of supplier audit

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