If you've been following along with our articles here, you'll know that the importance of acquisition due diligence has been a recurring theme in our discussions. That's because our experience informs our musings. And we've found that reasonably thorough, well-considered, carefully focused, and targeted acquisition due diligence is well worth the money it requires. Why can we say this? Well, because if due diligence is done as it should be, it heads off disappointments and issues post closing.
When speaking with current or potential clients, there's a classic analogy we use to communicate the importance of due diligence. This is a situation we can probably all relate to - buying a used car. You wouldn't sign on the dotted line before having your trusted mechanic give the car you're considering buying a onceover. Now why's that? It's because you trust their expertise and hold them to be trustworthy in general.
You know that if your mechanic notices something wrong or even the potential for future issues, they will let you know without hesitation. That way, you have an informed opinion and you also have options. If the used car turns out to be a lemon, you can quite simply back out of the deal. On the other hand, if the used car is in reasonably good condition, you can proceed to buy it with confidence. Your goal is to ensure that the car is safe and won't pose any major issues, not that it's the picture of perfection - it's a used car after all.
But what if the car comes with a warranty? Is it still recommended to get it checked out before buying? We will always say yes. Because even if the car will come with a warranty, who really wants to make claims under the warranty if they can avoid it? No one wants that hassle.
The same is true when buying a business. Acquisition due diligence will help to establish that the prospect is in good condition and that there aren't glaring issues that will be hard to resolve, not that it's perfect in any way. And even though you are getting full benefit of the warranties and indemnifications of a well-crafted purchase agreement, at the end of the day no one wants to be tasked with making post-closing claims against the seller if they can avoid it. We're talking about a whole lot of hassle, including the inevitable deductibles and other headaches.
At Calkins Law Firm our business law attorneys have assisted buyers with hundreds of acquisitions over the past several decades. While we don't make a practice of tracking acquisitions after closing, we are aware of some of the results. And we can honestly say that we're only familiar with a handful of situations in which the buyer struggled post closing.
In these cases, buyers felt that they had valid claims on the representations and warranties insurance, a policy used to protect against losses arising from a seller's misrepresentation. Whether the alleged breach is of representation or warranty, the buyer is looking for compensation. The overall situation is stressful, disappointing, and a major headache for all parties involved. But the saddest truth is that in most if not all of these situations, we feel that had the buyer opted for reasonably thorough due diligence, they could have avoided post-closing claims and the associated struggles.
And so it is with this real-life experience backing us that we recommend all business buyers conduct the necessary due diligence on any acquisition target well before closing. This is true regardless of how strong the representations and warranties insurance and indemnification prospects in the purchase agreement may be. At the same time though, one thing we don't recommend is being over-cautious or throwing excess amounts of cash at due diligence efforts. As with everything in life and law, balance is key.
We have been involved with transactions recently where the buyers reportedly spent over $1 million on acquisition due diligence alone, and where the parties also took out representations and warranties insurance. From our experience, if a buyer does targeted due diligence prior to closing, claims for breach of representation and warranty and for indemnification are few and far between. With that knowledge in hand, we sometimes scratch our heads and wonder whether spending vast sums of money on acquisition due diligence and related insurance is necessary. Could it be overkill?
In the end, the simple truth could be that it's easier to exhaustively probe everything about an acquisition target than it is to strategically focus on what really matters. Yet that's what we do for our clients, every day.
Real-Life Legal Expertise
At Calkins Law Firm we are proud to offer our clients consistently high-quality, in-depth service. We'll also be happy to share plenty of advice and suggestions, based on experience and know-how. Regardless of company or transaction size, our team is always ready to tackle your requests with a practical eye and an efficient approach. If you want to work with a legal team that understands what's at stake in any transaction and is ready to advise with an eye on value, look no further. Reach out today to learn more about us and the legal help we offer.