Anyone wishing to acquire a company or take a stake in one should know exactly what they are getting into. It is not merely a question of the purchase price or the business idea, but of a deep understanding of the economic, legal and financial foundations of a company. This is precisely where so-called due diligence comes in.
It is a central element of every major transaction – whether a corporate acquisition, a merger or an investment by external financiers. In this article, you will learn what is meant by the term "due diligence", when and why it is carried out, and what different forms it takes. The aim is to give you, as an entrepreneur or potential investor, a fundamental understanding of this important instrument of company valuation and risk assessment.
Outline
1. What is a due diligence?
2. When do I carry out a due diligence?
3. What forms of due diligence exist and what do they mean?
4. Why do I need a due diligence?
5. What is the outcome of a due diligence?
1. What is a due diligence?
"Due diligence" literally means "required care". It refers to the careful examination of a company prior to an economically significant decision. The aim is to collect, analyse and assess information about the company. The idea is to identify opportunities, risks and potential problems at an early stage in order to be able to make a well-founded decision.
In practice, this means that experts – including lawyers, tax advisors and auditors – systematically scrutinise the target company. They review contracts, balance sheets, business models, customer relationships, legal risks and many other aspects. In doing so, they also examine whether the company is viable in the future and whether there may be any hidden risks.
2. When do I carry out a due diligence?
A due diligence is generally carried out in the following situations:
• In a corporate acquisition (M&A transactions): The buyer wants to know what they are buying. A superficial assessment is not enough here.
• For corporate investments: Investors want to safeguard their capital and not invest in companies whose situation is unclear.
• Before initial public offerings or capital increases: Here too, a transparent presentation of the company's situation is decisive.
• In the context of corporate succession: When a company is transferred to successors, there should be clarity about the state of the company.
Depending on the complexity and scope of the transaction, a due diligence can take several weeks or several months.
3. What forms of due diligence exist and what do they mean?
A due diligence can consist of several sub-reviews, each with different areas of focus. The most important are:
• Legal Due Diligence: Examination of the legal relationships. This includes articles of association, shareholder lists, employment contracts, pending litigation, compliance issues and industrial property rights.
• Financial Due Diligence: Analysis of the company's financial situation. This examines, among other things, balance sheets, profit and loss statements, cash flows, tax documents and debts.
• Commercial Due Diligence: Assessment of the business model, market position, customer structure, competitive situation and strategic outlook.
• Tax Due Diligence: Examination of tax risks, particularly with regard to tax audits, tax liabilities and tax structuring opportunities.
• Technical Due Diligence: Technical review, e.g. for real estate or in industrial sectors. This concerns plant, machinery, production processes and IT infrastructure.
• Environmental Due Diligence: Investigation of possible environmental pollution or contaminated legacy sites, particularly relevant in industrial sectors or in real estate.
Depending on the transaction, not all forms are always carried out – the selection depends on the specific project and the sector requirements.
4. Why do I need a due diligence?
Due diligence can serve several purposes. First, the aim is to achieve risk minimisation. Potential risks – whether legal, financial or economic in nature – should be identified at an early stage. At the same time, due diligence can serve price determination. The results of due diligence can have a significant impact on the purchase price. If defects are discovered, this can lead to price reductions or contractual safeguards. From the examination of the individual points, certainty in negotiations for the conclusion of a purchase agreement can then be gained. Anyone who has carried out a comprehensive review can negotiate with greater confidence and information.
However, the information obtained also serves to avoid liability. For managing directors, board members and investors, a properly conducted due diligence can help to avoid personal liability risks. If due diligence is not carried out and a previously known risk later materialises, liability risks may arise.
5. What is the outcome of a due diligence?
At the end of the due diligence there is usually a detailed report – the so-called due diligence report. It documents the areas examined, assesses any risks and gives recommendations for further negotiations. The report often serves as a basis for drafting the purchase agreement, particularly with regard to warranties, liability clauses and rights of withdrawal.
A well-conducted due diligence process is not only a legal mandatory exercise but a strategic instrument that can decisively determine the success of a transaction.
Conclusion
Due diligence is a central tool for entrepreneurial decisions with far-reaching consequences. It protects buyers and investors from unpleasant surprises and creates the basis for fair and legally secure transactions. As a Certified Specialist Lawyer for Commercial and Corporate Law (Fachanwalt für Handels- und Gesellschaftsrecht), Mr Maximilian Rohrbach will be pleased to support you in the planning, execution and legal accompaniment of your due diligence – so that your investment rests on a secure foundation.
