You are buying a company for the first time and someone has told you that you need "due diligence". You probably realise it is some kind of review. What exactly we review, why, and what it means for your decision, however, most buyers only find out along the way.
Due diligence decides whether you are really buying what you think you are buying. In our practice, we concentrate on four core areas.
¶ 1. Legal review: contracts, disputes, IP, real estate
The first and most extensive area. We go through the target company's key contracts: supply, customer, lease and licence agreements. We look for provisions that could turn into a problem after a change of ownership.
A typical example from practice: we were acquiring a company whose main customer had a change-of-control clause in its contract. If the supplier's ownership structure changed, the customer could terminate immediately. And that contract accounted for 40% of the target's revenue. Without due diligence, the buyer would have learned of the risk only after the transaction closed.
We also review ongoing and threatened litigation, the registration and ownership of trademarks, patents and other intellectual property, the condition of real estate, and easements. Often, what tells us most is what is missing from the documents.
¶ 2. Corporate review: who actually owns what
It sounds simple, but in practice this is where the biggest surprises turn up. We review the ownership structure: who holds the shares, how they acquired them and whether the shares are encumbered by pledges or pre-emption rights.
An example: in one transaction, we found that ten years earlier the founder had given a 30% stake to his wife. The gift, however, had not been made in the prescribed manner, and the commercial register entry did not match reality. The ownership structure the seller was presenting was therefore not legally valid.
The corporate review also includes an analysis of general meeting resolutions, managing director service agreements, consents and powers of attorney. We look for gaps in decision-making that could be used to challenge the validity of earlier transactions or of the company's obligations.
¶ 3. Regulatory review: licences, permits, compliance with regulations
Some industries require specific licences or permits, for example healthcare, energy, financial services, waste management or food production. We check whether the target company holds all the necessary authorisations, whether they are valid and whether they are transferable.
An example: the buyer was interested in a company that ran a network of outpatient clinics. Due diligence revealed that the whole network depended on a single designated professional representative (odborný zástupce), who was about to retire. The healthcare licence does not lapse when that person leaves, but the company must appoint a new representative who meets the statutory requirements within ten days and apply to have the licence amended (Section 14(5) of the Czech Healthcare Services Act). Whether a successor could be found in time was uncertain, and this fundamentally changed both the transaction structure and the purchase price.
The regulatory review also covers compliance with data protection rules (GDPR), environmental law and antitrust rules, as well as a check of sanctions lists.
¶ 4. Employment review: staff, contracts, liabilities
Employees are often the most valuable asset of the company being bought, and at the same time a source of hidden liabilities. We review employment contracts, pay terms, benefits, collective agreements, ongoing employment disputes and potential claims.
An example: in one acquisition, we found that eight managers at the target company had non-compete clauses that had not been properly agreed, because they lacked adequate consideration. Had these people left after the acquisition, the clauses would have been unenforceable and the key managers could have gone straight to a competitor.
We also pay particular attention to informal arrangements, meaning verbal promises of bonuses, promotions or profit shares that you will not find in the documentation but that employees are counting on.
¶ When you don't need due diligence
Due diligence is not always needed in full. If you are buying a smaller company with a simple business, a single owner and a clear history, a streamlined legal review focused on the key risks may be enough.
The complexity of the target matters more than the size of the deal in crowns. A business with CZK 50 million (roughly EUR 2 million) in revenue, one main customer, three employees and a simple business model is less risky than one with CZK 10 million in revenue, a complex ownership structure, twenty employees and operations in a regulated industry.
¶ Due diligence as an investment
Buyers often see due diligence as a cost. Legal advisers cost money, the review takes weeks and closing is pushed back. All of that is true.
But consider the alternative. Without due diligence, you are buying the company as it looks from the outside. If you discover a hidden problem only after the transaction, you have no negotiating position left: the share is paid for and the contract is signed.
Due diligence is not only for finding problems. It gives you the basis for a decision, whether that decision is to buy, to buy at a different price, to buy with different warranties or not to buy at all.
In roughly one-third of the transactions we handle, due diligence leads to a lower purchase price. In about ten percent, the buyer walks away. Either way, the cost of the review is recovered many times over.
Buying a company without due diligence is like buying a house without a survey. It may turn out fine. If it does not, the review you skipped will cost you far more than you saved on it.
If you are considering an acquisition and are unsure how extensive a review you need, we are happy to go through your situation and propose an approach that fits the transaction. I described a concrete cross-border case in Cross-border acquisition: lessons from healthcare robotics. Before you embark on an acquisition, also check that your articles of association and basic contract clauses are in order.
Considering an acquisition and need to know how deep your review should go? In our transactions practice we set the scope of due diligence according to the risks of the specific target. Get in touch.
¶ Frequently asked questions
Do I need due diligence when buying a small company?
Not always in full scope. For a smaller company with a simple business, a single owner and a transparent history, a streamlined legal review focused on key risks may be enough; the deciding factor is the target's complexity, not the deal value.
What does a corporate review check?
Who holds the shares, how they were acquired and whether they are encumbered by pledges or pre-emption rights. It also covers general meeting resolutions, managing director service agreements, consents and powers of attorney, because gaps there can call earlier transactions into question.
What should I watch for regarding the target company's employees?
Hidden liabilities and improperly drafted non-competes above all. In one case, eight managers had non-compete clauses without the required consideration, so they would have been unenforceable; verbal promises of bonuses, promotions or profit-sharing are another risk.
What if I discover a hidden problem only after buying the company?
At that point your negotiating position is zero, because you have already paid and the contract is signed. That is why due diligence comes before closing, while you can still buy at a different price, with different warranties, or not at all.
What does a regulatory review cover?
It checks that the target holds all necessary authorisations and that they are valid and transferable. It also covers GDPR compliance, environmental law, antitrust rules and sanctions lists.