Due Diligence in Mergers and Acquisitions: Seller Considerations’

This story was originally published by Law360™ Canada, (www.law360.ca) a division of LexisNexis Canada.

By Charlie Kim, Matthew McGuigan and Maria Sillano

Due diligence is the process by which the buyer in an M&A transaction investigates and evaluates the business or assets being sold. Buyers typically begin this process early in the transaction and it tends to continue right up to closing day. Sellers, however, do not always turn their minds to the process until they receive due diligence requests from the buyer. Owner managers are understandably focused on running their businesses, and preparing for a potential sale often takes a back seat. This article outlines the benefits of proactive due diligence for sellers and key considerations to facilitate the process.

I. Types of Due Diligence

Due diligence in a private M&A transaction is generally organized around the following categories: 

• Financial due diligence consists of an analysis of the business’ financial condition and tax affairs. This includes a review of financial statements, corporate tax returns, and financial projections. Owner managers will need to engage internal and external accountants to help prepare the required financial information for the buyer’s financial due diligence. Buyers may also request a Quality of Earnings report, which assesses whether a target business’ reported earnings accurately reflect its underlying and sustainable operating performance, including by identifying non-recurring, unusual or non-operating items.

• Legal due diligence involves a review of the target's contracts, minute books, and litigation history to determine exposure to pending and potential claims. It also includes obtaining Personal Property Security Act searches, writs of execution, and other registry searches to identify undisclosed security interests or judgments against the business. Further, where contract review reveals change of control provisions or other consent or notice requirements, obtaining third-party consents can potentially delay M&A transactions. Sellers must therefore balance the time needed to obtain consents against the risk of premature disclosure to third parties such as customers, banks, or suppliers.
  

• Operational due diligence refers to a review of a target company's business operations, such as its facilities, equipment, technology, and supply chain, to assess (sometimes with input from specialists such as environmental consultants) whether it can operate sustainably after closing. It also involves assessing the management team and other key employees, general workforce, and customer/supplier relationships. Overall, the goal of operational due diligence is for the buyer to assess operational hazards that may increase the risk in pursuing the transaction.
  

II. Benefits to Proactive Due Diligence

Owner managers who take a proactive approach in preparing for due diligence gain meaningful advantages in a sale transaction, such as:

• Mitigating problems before buyers find them: A proactive review lets sellers identify and address issues on their own terms (correcting them or determining how best to explain them) before the buyer finds them.
  

• Verifying representations and warranties: Sellers in M&A transactions must make a broad range of representations and warranties. If these statements prove inaccurate, the buyer may have grounds to terminate the agreement, walk away from the deal or seek damages for losses incurred in reliance on the misrepresentation. Owner managers who have prepared for due diligence will be able to review the representations and warranties with greater context, thus reducing the risk that they misrepresent a material fact.
  

• Purchase price considerations: Buyers who uncover unexpected risks during due diligence often use them as leverage to renegotiate the terms of the deal, including purchase price. A well-prepared seller is less likely to face purchase price reductions or last-minute concessions from issues discovered during due diligence.

III. Key Considerations for Sellers During Due Diligence

a) Confidentiality

Before sharing information, sellers should have a Non-Disclosure Agreement (“NDA”) in place. The NDA should clearly set out what information can be shared, who can access it, and how it can be used.

The NDA must also ensure the seller is not in breach of any privacy laws in disclosing information to the buyer, such as employee names, and addresses. Under the Personal Information Protection and Electronic Documents Act (Canada), the use and disclosure of personal information without consent of the individual is permitted in the context of a prospective sale, provided the NDA restricts the buyer's use to transaction purposes, requires safeguards, and mandates return or destruction of the information if the deal does not close.

Owner managers should engage M&A counsel early to ensure that an NDA is entered into with the adequate provisions that serve to protect the seller’s confidential information and prevent unintended contravention of privacy laws.

b) Due Diligence Workflow

Sellers should also establish clear internal protocols for handling sensitive documents, including who may share them and through what channel. In practice, this typically involves gathering and vetting materials, which are then organized and uploaded to a Virtual Data Room (“VDR”) – a secure, password-protected online platform with controlled access.

c) Strategy

Sellers should approach disclosure strategically, reserving the most competitively sensitive information (e.g., customer lists, employee details, pricing, etc.) until the deal is sufficiently advanced. For example, sellers often wait until the transaction is more advanced and the likelihood of closing is higher. Whether information is “sensitive” depends on the business and sellers should carefully consider which details should be withheld from disclosure in the early stages of due diligence.

d) Ongoing due diligence required

Due diligence is not a one-time exercise. Because the business continues to operate while the transaction is negotiated, new information will arise and existing information will change. For example, a data breach may occur or employees may quit, which will impact the due diligence process. The VDR and any representations and warranties need to be reviewed and updated on an ongoing basis throughout the transaction to ensure that they all remain accurate and up-to-date.

IV. Conclusion

Due diligence is a critical component of M&A transactions for both buyers and sellers. Sellers who take proactive steps early and on an ongoing basis are better positioned to identify and address risks before they affect the transaction. Experienced M&A counsel can help identify issues early, coordinate the due diligence process, and guide sellers through each stage of the transaction.

Matthew McGuigan is an Associate in the Business & Transactions Group at Robins Appleby LLP. He is an Ontario lawyer advising on mergers and acquisitions, debt financing, private capital markets, and shareholder and partnership arrangements in the Canadian, cross-border, and international context. With a dual JD/HBA from Western University and Ivey Business School, Matthew applies his business acumen to address his client's legal needs.

Maria Sillano is a summer student.

At Robins Appleby, we have been providing legal advice for over 70 years to entrepreneurs, businesses, financial institutions, and foreign companies operating in Canada. Located in Toronto's financial district, our firm is trusted by clients to help solve critical, time-sensitive issues. We offer a wide range of legal services including business and transactions, affordable and social housing, litigation and dispute resolution, commercial real estate development, tax law, employment law, and estate planning.