Due diligence

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A due diligence check , often shortened to Due Diligence ( DD ) in accordance with English legal and business jargon , describes a careful check that is carried out - usually initiated by the buyer - when buying shares in companies or real estate, as well as when going public . Due diligence checks (translated as "due diligence") analyze the strengths and weaknesses of the property as well as the corresponding risks and therefore play an important role in determining the value of the property.

Buyer and seller agree on the period and scope for the due diligence review, whereby the payment of a fee can be agreed if a purchase does not materialize. During due diligence, i. d. Usually external consultants (tax consultants, lawyers, auditors etc.) are consulted.

Origin of the term

The term due diligence comes from the US-American capital market and investor protection law ( securities laws ) and concerns liability regulations for the persons involved in trading in securities. The Securities Act (SA) of 1933 regulates the initial issuance of securities. According to sec. 11 (a) SA 1933, the testator auditor in relation to the first advertisers liable of a security offered to the public for any losses suffered by them in the relevant security if the registration information with the Securities and Exchange Commission SEC misleading information contained (prospectus liability). The so-called due diligence defense offers the auditor the opportunity to evade this liability if he can prove that he carried out the audit with due diligence .

According to sec. 11 (b) (3) SA 1933, the auditor is not liable if “he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading ... " . Regarding the question of the content of the terms "reasonable investigation" and "reasonable ground", sec. 11 (c) SA 1933 regulates: "the standard of reasonableness shall be that required of a prudent man in the management of his own property." The term due diligence in US liability law is therefore comparable with the institute of "due diligence required in traffic" anchored in German law.

In addition, the term due diligence has acquired a wider meaning. In general, this is understood to mean the careful analysis, examination and evaluation of an object in the context of an intended business transaction, but especially in connection with company acquisitions. It is about the procurement and processing of information in the sense of a purchase or takeover test. The aim of the procedure is to uncover hidden opportunities and risks in the target company in order to improve the quality of the decision and to increase the accuracy of the valuation due to the improved level of information.

In US law, due diligence is of further importance in connection with warranty claims. The buyer's duty of care ( caveat emptor ) applies here . This duty of care imposed on the buyer makes it necessary to carefully examine an object of purchase. This view contradicts the idea of ​​the seller's contractual duty of care. In US law, the honest seller is generally not liable for defects in the purchased item, so that special warranty agreements must be drawn up for the individual purchase contract. An opportunity and risk analysis as part of a due diligence review forms the basis for this. German law, on the other hand, does not assume that the buyer has an obligation to examine the subject of the contract.

Practical implementation

The company to be sold will set up a data room for the actual implementation of the DD . In this data room, all documents are provided that the company to be sold wants to make available to the buying company.

The results are summarized in a data room report for the buyer. The report highlights the identified strengths and weaknesses of the company being sold. Quantifiable results flow into the company valuation and thus the determination of the buyer's offer price. Non-quantifiable results, on the other hand, lead to the requirement for declarations of exemption and guarantees in the company purchase agreement.

Types and occasions of due diligence

Buy side due diligence

The buyer of a company initiates the due diligence. He selects the appropriate specialists who examine the company to be acquired for him. The results of the investigation are included in the buyer's proposal for a purchase price or in the guarantees required by him.

The focus of buy side due diligence differs from the perspective of the respective buyer. In particular, a distinction must be made between strategic buyers, i.e. buyers who want to grow in their industry or, if necessary, also want to diversify into other industries, and financial investors who acquire the company for profit considerations. The main difference arises from the different requirements for financing the transaction. While the financial investor usually finances the acquisition to a high degree with outside capital, the acquisition of a strategic investor is mostly financed through own funds.

Vendors Due Diligence

The seller himself uses due diligence to prepare his company or part of it for a sale. After the due diligence, he is able to identify and eliminate any weaknesses in the company. In this way, he is relatively safe from negative surprises after a buyers due diligence.

In addition, vendors due diligence makes sense if the company is to be offered to several buyers, as this reduces the effort on the buyer side. Due to the anticipated different interests of the potential buyers (strategist vs. financial investor), the vendor due diligence i. d. Usually more extensive than the buy side due diligence. Due to the different focus of analysis of possible buyer types, there is a conflict of objectives between the focused presentation and the addressing of relevant information for different buyer types when carrying out a VDD.

Due diligence before an IPO

Another area that DD reviews are conducted is in company listing . In the case of a public offer of securities in Germany, a securities prospectus must be drawn up in accordance with Section 3 WpPG to provide information to investors.

Investors are liable for damage caused by incorrect or incomplete prospectuses under Sections 20 et seq. Of the Asset Management Act or Section 13 of the VerkProspG, or for unpublished ones from Section 13a of the VerkProspG, the issuer, the issuer accompanying the issue (bank, banking syndicate) and certain other persons.

DD's task in the IPO is to ensure the completeness and correctness of the prospectus. Furthermore, the aim of the emissions monitor in particular is to free itself from the charge of gross negligence in the event of a dispute by referring to the DD ( due diligence defense ). Finally, the DD serves to enable the bank to recourse against the experts deployed, provided that they did not proceed carefully during the examination and thereby triggered the bank's liability.

In the UK , the DD requires 3 reports for an IPO:

  • long-form report : detailed analysis by the external auditor
  • short-form report : Brief version of the analysis with a description of the task and the main results
  • Working capital report : Analysis of the expected liquidity situation in the next 24 months

In Germany, the scope of the DD report for an IPO is not defined by law, but results from the contractual relationship between issuing banks and lawyers, tax consultants and auditors commissioned. Due to the Anglo-Saxon character of many employees of the issuing banks, however, the content required in Great Britain can also be found in the reports for German IPOs.

Outsourcing due diligence

In the context of tenders, especially in the IT and BPO area, the service providers often conduct due diligence with the tenderer. Important aspects are e.g. B. Number, profile and salary of the employees to be transferred, efficiency of the processes, age and value of the IT assets such as servers , PCs or maintenance contracts. As a rule, a binding offer can only be made to the tenderer after it has been carried out. However, the process of due diligence in this area is no guarantee of a successful and profitable business relationship between the tenderer and the winner of the tender.

Functional forms

  • Strategic Due Diligence: strategic view of industrial, financial and speculative investors, strategic planning, determination of synergy potential
  • Financial due diligence: Examination and forecast of assets, earnings, cash flow , liquidity, equity and debt capital raising, financing structure, options for cash pooling - summary determination of deal issues and deal breakers
  • Operational Due Diligence (Operations Due Diligence): The test, usually abbreviated as ODD, evaluates the risks and potential for increasing value of the target company's operations. It is usually carried out as part of transactions in the industrial sector, with engineering, supply chain and production being the focus. Private equity investors, in particular, regularly use the additional knowledge of this form of due diligence to support decision-making in the transaction phase and to prepare for the operational increase in value after closing.
  • Commercial Due Diligence: Commercial Due Diligence analyzes the market and in particular the value chain of the business model. Market, competitive analysis, benchmarking , customer, product, pricing and USP . The commercial due diligence answers the question of the sustainability of the business model.
  • Tax due diligence: tax law situation and perspective of the target, decisive tax influencing factors of the transaction, transformation and group tax analysis, risk analysis with regard to taxes (including ongoing tax audits, pending tax court proceedings), structuring of the acquisition (write-off of the purchase price, tax-efficient financing of the transaction, Inclusion in the tax group, preservation of loss carryforwards, structuring / checking of any transfer taxes that may be incurred, in particular real estate transfer tax and sales tax)
  • Legal due diligence: legal risks and pending legal disputes, copyright, labor and antitrust reviews, merger control, review of existing rental and lease agreements
  • Insurance / Risk Due Diligence: Liability and cover-related risk determination and evaluation of the insurance concept of a company and its risk management (CapEx-relevant topics, emergency plans, costs for self-bearing a risk, etc.)
  • Market due diligence: market situation, internal company analysis, external company analysis, plausibility check of planning, data sources and success factors
  • Human Resources (HR) and Organizational Due Diligence: Analysis of structural human capital , analysis of individual human capital and the organizational structure of the company
  • Cultural Due Diligence: Social norms, manners and customs that have grown organically from the concept of human beings and the self-image of the employees. They can be very different depending on the industry. The complications that can arise here are possibly in an analogy with European aid projects e.g. B. in Africa comparable: Those who are not willing to try to get a real understanding of the mentalities will not be able to help the local people. Acquiring this understanding is time consuming.
  • Technical Due Diligence: The technical condition of plants and buildings is examined, here in particular with the aim of evaluating maintenance, repairs and modernization potential (high priority for property DD).
  • Environmental Due Diligence: Environmental quality of the location of its facilities and buildings. In addition to contaminated sites (armaments / war-related contaminated sites, underground contamination from previous industrial or technical use), soil pollution from recent use is examined. The location of the site with regard to a future protected status (protected area status, e.g. bird sanctuary) is assessed. Finally, building pollutants (use of asbestos products in the building fabric, presence of other pollutants) that can cause additional costs in the case of demolition or renovation work are recorded ( pollutant register ). Lately, energy efficiency has become an important part of the EDD. This area is processed in connection with the technical due diligence.
  • Digital Due Diligence: see IT Due Diligence.
  • IT Due Diligence: The examination of opportunities and risks within the company's IT. The opportunities include synergy potentials, efficiency potentials and strategic IT assets. In the area of ​​risks, operational risks, monetary risks and dependency risks are checked and assessed. The future security as well as the cost awareness of IT is checked in order to assess the value contribution of IT to the overall company. The IT risk assessment has increased sharply in recent years due to the digitization of many corporate areas. The introduction of data-driven, IT-supported company processes require a more in-depth examination of the implementation. The use of complex algorithms ( data mining , predictive analytics ) increasingly automates decisions with the help of the company's IT systems and the algorithms become part of the critical risk assessment (e.g. in logistics, at FinTech companies or in automated trading ). When it comes to digital business models , one also speaks of digital due diligence.
  • IP Due Diligence: Examination of the company's intellectual property (IP). Which patents, trademarks, designs and licenses does the company have, in which countries etc. Are these property rights in force, legally valid and enforceable or are they subject to legal defects? Do the property rights adequately cover one's own products and services or the products and services fall under the property rights of third parties; licenses are therefore required.
  • Merger integration due diligence: examines the integration plans of a merger and helps to ensure the success of the integration.
  • Integrity Due Diligence : Investigating the risk of these partners engaging in illegal or dubious business practices

Criticisms

Planning and commissioning of consultants

Assuming that there is fundamentally an information asymmetry between seller and buyer, the buyer is dependent on making assumptions about the property to be acquired. When planning due diligence, these assumptions are often not made transparent, even though they would be an essential starting point for efficient due diligence.

Success-oriented remuneration of the consultants employed

Consultants who are commissioned to carry out due diligence are often remunerated on a success-oriented basis, i. H. If the transaction is successful, a higher fee is paid than if the transaction is canceled. This desire, which is initially understandable from the client's point of view, not to have high fees and thus costs ("broken deal costs") in the case of aborted transactions, however, leads to a conflict of interest for the mandated consultants, since they should not have any economic disadvantage from having to abort Advise a transaction based on risk considerations. In Germany, performance-based remuneration is only permitted in exceptional cases (Section 49b (2) BRAO, Section 4a RVG) and is therefore not common.

execution

Often, due diligence work is carried out on the basis of due diligence checklists without questioning whether the information and analyzes mentioned on the due diligence checklist are actually relevant for the client and his goals. The result is extensive reports that are of limited use to the acquirer.

literature

Monographs and edited volumes

  • Patrick Sinewe (Ed.): Tax Due Diligence. Gabler , 1st edition 2010, ISBN 978-3-8349-1440-8 .
  • Daniel Beisel, Friedhold E. Andreas (Eds.): Beck'sches Mandate Handbuch Due Diligence. CH Beck , 2nd edition 2010 ( ISBN 978-3-406-58973-7 ), 3rd edition 2017.
  • Wolfgang Berens, Hans U. Brauner, Joachim Strauch (eds.): Due diligence in company acquisitions. 4th edition. Schäffer-Poeschel-Verlag, Stuttgart 2005, ISBN 3-7910-2338-1 .
  • Luise Hölscher, Anke Nestler, Ralf Otto: Handbook Financial Due Diligence. Wiley Verlag 2007, ISBN 978-3-527-50295-0 .
  • Thomas Koch: Due diligence and acquisition of shares from the perspective of insider law. NOMOS 2006, ISBN 3-8329-2427-2 .
  • Wolfgang Koch, Jürgen Wegmann: Practitioner Manual Due Diligence: Analysis of Medium-Sized Enterprises. Schäffer-Poeschel , 2nd edition 2001, ISBN 3-7910-1850-7 .
  • Denzil Rankine, Graham Stedman, Mark Bomer: Due Diligence: Definitive Steps to Successful Business Combinations. Financial Times / Prentice Hall, 2003, ISBN 0-273-66101-9 .
  • Aliresa Fatemi: The duty of due diligence when buying a company. Nomos, 2009, ISBN 978-3-8329-4622-7 .
  • Philipp Ehring: The due diligence in the tension between sales law liability system and contractual design . Peter Lang 2010, ISBN 3-631-60488-2 .

Essays

  • Wolfgang Berens, Walter Schmitting, Joachim Strauch: Functions, scheduling and legal classification of due diligence. In: Wolfgang Berens, Hans U. Brauner, Joachim Strauch (Eds.): Due Diligence in Company Acquisitions. 4th edition. 2005, pp. 75-118.
  • Klaus-Günther Klein, Martin Jonas: Due Diligence and Company Valuation. In: Wolfgang Berens, Hans U. Brauner, Joachim Strauch (Eds.): Due Diligence in Company Acquisitions. 4th edition. 2005, pp. 175-195.
  • Jens Leker, Arne Fischer, Hans-Jürgen Wieben, Dirk Mahlstedt: Due diligence and company rating according to Basel II. In: Wolfgang Berens, Hans U. Brauner, Joachim Strauch (eds.): Due diligence in company acquisitions. 4th edition. 2005, pp. 221-247.
  • Werner Mielke: Due Diligence. In: HJ Knott, W. Mielke (Ed.): Company purchase. 3. Edition. Cologne, 2008, margin no. 23 ff., P. 7.
  • Dirk Narwe, Frank Nagel: Vendor Due Diligence. In: Wolfgang Berens, Hans U. Brauner, Joachim Strauch (Eds.): Due Diligence in Company Acquisitions. 4th edition. 2005, pp. 757-784.
  • Peer Zumbansen, Constantin M. Lachner: The board's duty of confidentiality in due diligence: reassessment in globalized business. In: Journal for Comparative Law . Archive for International Business Law (ZVglRWiss) . 105 Vol., 2006, pp. 1-18.
  • Alexander H. Engelhardt: Environmental Due Diligence. In: Advice on commercial law. (WiB, sp. NZG) 1996, p. 299f.

Individual evidence

  1. ^ Adrian Henke, Stefan Boller, PROCOMM IT Concepts AG (eds.): Key factors of IT due diligence. (PDF) Retrieved March 12, 2016 .
  2. ^ Adrian Henke, Stefan Boller: IT Due Diligence - Fast, Detailed - or Not at All? (PDF) M&A Review, July 2016, p. 249 , accessed on February 26, 2018 .
  3. ↑ A. Nichau, niologic GmbH (Ed.): IT due diligence. Retrieved February 2, 2016 .
  4. ^ KM Popp (Ed.): IP due diligence. Retrieved March 22, 2014 .
  5. ↑ also dissertation, Saarbrücken University ( reading sample )