Due diligence before the deal: what do you examine before you pay?

You are buying a company or a stake or bringing in a partner, and everything in your hands is promises and figures. Due diligence is verifying the asset before you pay, and turning what you find into terms in the contract or a decision to walk away.

The scope of the review differs according to what you will buy: a hundred percent of an existing company, a minority stake, specific assets, or entry through a capital increase. It also differs if the value of the deal lies in the technology, the licence, the contracts or the management team more than in physical assets. Define the premise first, then build the checklist on it.

Three aims: to know the truth about what you are buying, to price the risks instead of being surprised by them, and to put into the contract what protects you from them. It is not suspicion of the other party but ordinary professional practice in transactions.

• The legal standing of the business: the commercial register, the articles of association or constitution, amendments and partners' resolutions, the licences the activity needs and their validity.
• Ownership: who is the real owner of the interests or shares, and whether they carry a pledge, encumbrance or agreement restricting dealing in them.
• Key contracts: with customers, suppliers, premises and key employees, and the terms in them triggered by a change of ownership or that contain exclusivity or a future commitment.
• Disputes: whether there are pending cases, potential claims or unenforced judgments.
• Financial obligations: loans, security, guarantees and overdue payables.
• Statutory obligations: zakat, tax, social insurance and labour compliance.
• Intellectual property: whether the trademarks and rights are actually registered in the company's name.
• Real estate assets: title deeds, leases and the encumbrances on them.
• Personal data: whether the company processes it in accordance with the Law.

You do not need to read all the contracts in the same depth. Identify the contracts that represent a significant share of revenue or costs, or that grant a licence, distribution or a strategic right. And look in them especially for: the effect of a change of ownership or control, termination and renewal, exclusivity, minimum purchase, liability and indemnities, and how disputes are resolved.

The claim already filed is not the only risk. Review unrecorded demands and claims, regulatory violations, labour disputes, customer and supplier claims, and any internal investigations. Some of these risks do not justify dropping the deal, but they do justify withholding part of the price or a specific indemnity.

Depending on the nature of the company, the value of the deal may lie in key employees, software, a brand or a database. Make sure of the ownership of these assets or of their licences, of the contracts of key staff and confidentiality arrangements, and of any restrictions relating to data or sector regulation.

Review the financing, pledges, security, financial covenants and any signs of distress. A bankruptcy procedure or a serious risk of default may change the structure of the whole deal, and it is not enough to list it as an item in the disclosure schedules.

• Missing documents that cannot be produced or that are stalled.
• A difference between what you were told and what is in the records.
• Oral contracts for fundamental relationships.
• Large obligations not recorded in the accounts.
• The business depending on a single customer, supplier or person.

What you find does not end in a report; it becomes one of two things: an adjustment to the price or the structure of the deal, or terms in the contract such as representations and warranties from the seller, indemnities for violations, and conditions precedent to completion such as discharging a pledge or renewing a licence. And occasionally the answer is to walk away.

Every important observation should end in a specific deal recommendation: a condition precedent to completion, a representation and warranty, an indemnity, a price adjustment, retention of part of the price until the risk is gone, an undertaking given by the seller, or a conscious acceptance with no special remedy. If the negotiator does not know what to do with the observation, the report is functionally incomplete. The value of the review shows in the purchase agreement, not in the number of pages of the report.

Start with an initial matrix: a list of requested documents against what has arrived, classifying the risks into what stops the deal, what is priced, and what is dealt with by a condition. After that you know where to go deeper and where reassurance is enough.