What vendor due diligence is
Vendor due diligence is a review commissioned by a seller to investigate the business before a sale process. It can identify issues that require attention and provide organised information for prospective buyers. The scope may include legal, financial, tax and other specialist reviews, depending on the proposed transaction.
In most sales of private businesses, due diligence is something done to the seller. The buyer sends a long list of questions, the seller scrambles to find documents it has not looked at in years, and problems surface at the worst possible moment: after the price has been agreed and the buyer has the leverage. Vendor due diligence reverses that sequence.
Why it is worth doing
It protects the price. Every problem a buyer finds in due diligence becomes a reason to renegotiate. A missing lease assignment, an unsigned customer contract or an unregistered trade mark may each be minor, but together they give a buyer the material for a price reduction or a retention. Problems found and fixed before the sale process never reach that stage.
It speeds up the deal. A seller with organised records and clean answers can run a short, controlled process. A seller assembling documents on request gives the buyer the pace, and a slow deal is a deal at risk.
It reduces warranty exposure. The seller will give warranties in the sale agreement about the state of the business. Anything the seller knows about is disclosed against those warranties and the buyer takes the risk. Anything the seller does not know about, and later turns out to be wrong, is a potential claim. Vendor due diligence turns unknown problems into disclosed ones.
It strengthens the seller's position. A seller who understands its own business better than the buyer does controls the narrative. That is worth a great deal in negotiation.
What it covers
The scope depends on the business, but a legal vendor due diligence review will usually look at:
- Corporate records. Share register, constitution, director and shareholder resolutions, ASIC filings and any shareholders agreement. In a share sale, the buyer is acquiring the company's entire history, and gaps in the paper trail raise questions about who actually owns what.
- Material contracts. Customer and supplier agreements, distribution and agency arrangements, and anything with a change of control clause, which may let the other party terminate when the business is sold.
- Employees and contractors. Employment contracts, award coverage, accrued entitlements, restraint clauses for key staff, and whether long-standing contractors are properly characterised.
- Property and leases. Whether leases are current, in the right name, assignable with the landlord's consent, and whether any options have been exercised correctly.
- Intellectual property. Who owns the trade marks, software, domain names and know-how the business depends on, and whether that ownership is registered and documented.
- Licences and regulatory compliance. The licences the business needs to operate, whether they are held by the right entity, and whether they transfer on a sale.
- Disputes and liabilities. Current or threatened claims, regulator correspondence, and anything that would need to be disclosed to a buyer.
- Security interests. Registrations on the Personal Property Securities Register against the company or its assets, many of which will be stale and need to be removed.
What it usually turns up
Few private businesses come through a vendor due diligence review clean, and that is the point. The problems are rarely fatal; they are the ordinary consequence of running a business for years without anyone asking for the paperwork.
The most common findings are contracts that were never signed or have expired and rolled on informally, trade marks registered in a founder's personal name rather than the company's, leases that have not been formally renewed, employment contracts that predate the current award, and old security registrations from lenders paid out years ago.
Most of these can be fixed in weeks once identified: a replacement contract, an assignment of intellectual property to the company, a consent from a landlord or key customer, a release of a stale registration. Fixed before the sale, they disappear. Found by a buyer, each one becomes a condition, a price adjustment or a specific indemnity.
Timing and the data room
Vendor due diligence works best when it starts three to six months before the business goes to market. That leaves time to fix what it finds, and it can mean that the documents a buyer asks for are already gathered, reviewed and organised in a data room.
A well-prepared data room does two things. It answers the buyer's questions before they are asked, which shortens the process. And it forms the basis of the seller's disclosure against the warranties in the sale agreement, so what is in it is what the seller is protected on.
Sellers who go to market without this preparation are not necessarily selling a worse business. They are selling the same business with less control over how it is presented, and at a higher risk of the price moving after it has been agreed.
How we can help
Rouse Lawyers acts for sellers and buyers of private businesses across Queensland and nationally. We carry out legal vendor due diligence, fix the issues it identifies, prepare the data room and manage the disclosure process through to completion. If a sale is on the horizon, the review is best started before the first buyer conversation.
Disclaimer
The information contained on this website is for general guidance on matters of interest only. The application and impact of laws can vary widely based on the specific facts involved.
Accordingly, the information on this site is provided with the understanding that the authors and publishers are not providing legal advice. As such, it should not be used as a substitute for consultation with professional legal advisers. Before making any decision or taking any action, you should consult with a professional lawyer from Rouse Lawyers.
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