For potential investors and acquirers, carrying out commercial due diligence prior to an acquisition is an important exercise to be considered as part of the wider due diligence process. Conducting commercial due diligence will help potential buyers to understand a target company’s commercial matters such as:
- the target’s key commercial contracts;
- any data protection issues; and
- any intellectual property matters
as well the associated risks concerning such matters.
Being aware of the correct questions to raise during the commercial due diligence process will help to highlight and potentially either avoid or mitigate risks and complications and ultimately ensure that an accurate valuation of the target company is obtained.
Commercial Contracts
Business relations
Understanding the business relationships that a target company has with its suppliers and customers will be a key aspect of the commercial due diligence process. To obtain such information, a review of the target company’s key commercial contracts will need to be completed. A review will enable potential buyers to:
- assess whether the existing contracts provide adequate protection to the target company. Consideration will need to be given to:
- whether the contracts have been formed on a standard or bespoke basis, as the construction of the contracts will provide understanding as to the complexity (legal and commercial);
- understanding their value;
- understanding the extent of each party’s contractual duties included within the commercial contracts; and
- establishing whether there are any onerous obligations.
- identify whether the contracts are a burden or a benefit to the target company and highlight those contracts which are revenue-generating contracts and those which are not profitable (or potentially no longer be fit for purpose). As such, distinguishing between these types of contracts will determine the relevance of each contract and focus can then be attributed to those contracts which are of a significant value to the business (and also identifying those which need attention to make them profitable, or alternatively those which should be exited if possible).
Do the contracts allow an exit?
It will be important for potential buyers to ensure that they receive the benefit of the contracts acquired from the target company. Where there is a change in the ownership of the target company, consideration will need to be given to any change of control provisions.
The inclusion of change of control provisions within a contract may trigger certain consequences. Such provisions may allow a supplier or customer to terminate a contract following the sale of the target company which could therefore put revenue for the buyer at significant risk. Alternatively, a change of control provision may simply require notification of a change in the ownership of the target company to a supplier or customer.
Further, the review should also identify the contractual length but also particularly whether either party to a contract has the right to terminate “without cause” (i.e. neither party is in breach, but a party can simply give notice to terminate) which would again put revenue at risk.
Following the purchase of the target company
Following an acquisition, the new owner may find that some of the terms contained within the acquired contracts may no longer be suitable for the business – i.e. certain terms or contracts may no longer be suitable where a large company acquires a small company. It may therefore be necessary to try, if possible, to renegotiate such terms so that the new owner can operate the business in a manner which appropriately meets the business’ needs. For example, when the contract was originally entered into, the target company may have subcontracted some of the services out to a third party because at the time it did not have the capability to perform those services itself - if the acquiring business has an in-house team providing a range of support services, these may be more appropriate – this could therefore potentially give rise to an additional income stream (or a cost saving by way of consolidation or synergies).
Data Protection
Processing personal data
Most businesses are likely to store and use personal information which will subsequently give rise for a business to comply with its data protection obligations. Therefore, during an acquisition, it is important to assess whether such obligations are being adhered to. Potential buyers should ensure that a general audit is carried out into the types of personal data being collected by a target company and how such data is being used within the business. This exercise will establish if the target company is acting in compliance with its obligations under the General Data Protection Regulation (where applicable) which will include its data processing duties.
Processing personal data – Customer v. Employee data
The main types of personal data to be reviewed during an acquisition include employee and customer personal data.
In understanding a target company’s collection of employee data, buyers will need to be informed of the flow of employee data within the business. This will identify the areas of the business (such as an outsourced function) which specifically process employee data in which certain obligations under the GDPR will apply to the business.
Similarly, buyers should also be informed of the extent to which customer personal data is collected by the target company. The data protection compliance of a company can be seen as a form of investment, as compliance with data protection laws avoids the cost and time in dealing with formal complaints and/or personal data breaches (and subject access requests).
Policies and procedures
To assist with understanding a target company’s compliance with its data protection obligations, a review of its existing policies should be carried out to ensure that it is meeting its legal obligations (particularly those which require businesses to put in place data protection policies where appropriate). Further, a review of the target company’s existing data protection policies and procedures will determine the level of protection that is afforded to the personal data that it processes.
Intellectual Property (“IP”)
The intellectual property that is held within a business can often be a valuable asset of a target company – in effect, its “crown jewels”. When assessing the IP related matters during an acquisition, buyers will need identify (where applicable):
- the types of IP held within the target company;
- if the IP has been registered;
- if there is a website and any domain names; and
- IP ownership. This issue will be of particular importance to a buyer as they would need to establish the owner(s) of the IP (which often is not the target company itself but the individual founders of the business).
The due diligence process may reveal the need for IP assignments to be entered into between the relevant parties, in order to affect the legal transfer of any IP rights (i.e. from a founder to the target company).
Further, a review of the target company’s IP licences should be carried out so that the buyer is aware of any restrictions that may apply to them in respect of the IP assets.
The acquisition of a business can be something of a minefield – we are here to help guide you through the process to enable you to maximise opportunities whilst minimising risk. If you are a potential buyer or investor seeking assistance with any of the matters discussed above, then please get in touch with one of the members of our Commercial team today.
Listen to our podcast on the commercial checklist for buyers here.
