25 March 2008
Due Diligence (DD) is the investigation process undertaken by a party planning to make an acquisition. Conducted effectively, DD can provide vital management information to assess the viability of a potential acquisition, reduce the vendor's valuation of a business, protect the buyer against risks and assist in the integration of the business after completion.
The DD exercise will usually draw together a multi-disciplinary team of legal, financial, accounting and tax advisers, as well as the buyer's own personnel. In any industry, the process will focus on certain key areas, such as:
• Understanding the target business
• Determining the structure of the transaction
• Confirming title to the assets being acquired
• Quantifying known liabilities and uncovering unknown liabilities
• Identifying any post-completion integration issues
• Identifying any consents that may be required
However, buying a construction company carries its own set of risks which a prospective buyer needs to be aware of in order to focus its enquiries during the DD process.
As anyone in the construction business will know, when a project goes wrong it can go spectacularly wrong. A crucial part of any construction-related DD exercise will be a review of the key construction and project contracts. Particular areas of focus include:
• Design liability and who carries the risk
• Ground conditions and environmental constraints
• Completion and how delays are addressed
• Bonds and guarantees (including performance guarantees)
• Collateral warranties
• Limitations on liability and liability periods
• Change of control provisions
• Defects regime
Where the buyer is a significant player in the market already, these areas may be part of the risk which it expects to take on when buying the business, however, the buyer may still want the DD review to focus on particular risk areas such as design risk. The buyer will also want to be comfortable at the time of exchange that customers will continue dealing with the business following the acquisition.
Workers are likely to be an important part of any construction business and will be a central part of the DD exercise. The question of to what extent the target company has its own employees and to what extent it uses self-employed staff is important, as they are likely to have different employment rights. The type of acquisition – either a share purchase or an asset transfer – could also be significant as rights of employed and self-employed workers could be different under each deal type, depending on the jurisdiction.
Pensions have become an increasingly important issue on M&A transactions in recent years as many defined benefit schemes are now considerably under-funded. Where a business operates or has operated such a scheme, a key question will be the level of funding in that scheme.
In view of the numerous investigations into anti-competitve behaviour in the construction sector and the heavy fines being issued for infringements, it is crucial to make inquiries as to whether the target has been involved in any infringements of competition rules. The most likely issue is whether they have been engaged in any form of collusive tendering. This may include such activities as bid rigging, market sharing and price fixing. If this issue is not addressed at the time of acquisition, liability for fines for past breaches remains with the acquired company even if the anti-competitive behaviour has ceased.
Where the target business owns a large amount of real estate, a large element of the DD exercise will include an investigation into the title to those properties.
Where the assets of the target business include land used or previously used for industrial use, environmental DD will be needed to identify potential responsibility for any clean-up and liability generally for environmental damage. The buyer will need to decide on the level of investigation required; anything from a brief site visit and “desk top survey” to a more detailed survey. The aim is to determine and allocate responsibility for clean-up and to obtain appropriate protection.
Part of the key to successful DD is communication of the results to those responsible for making the decisions. Timing is crucial; the DD review is usually carried out in tandem with the negotiation of the acquisition and any significant information which might affect negotiations should be communicated immediately to the client even where the DD exercise is incomplete.
If done effectively DD can make or break a deal. The key to its success is an understanding of the major business drivers both in the sector as a whole and particular to the target business.