KEEP IT SIMPLE – BUY ONLY WHAT IS NEEDED
The scope of a Due Diligence programme will vary, dependent on exactly what is to be purchased. An acquisitor will usually want to buy – “The Business” – a parcel of income, less expenses, the goodwill inherent in a firm of good standing and reputation with the necessary assets for operation of the premises, buildings, equipment, records and staff.

The purchase of a business is far less complex than the purchase of shares in a company that will become a subsidiary needing to be wound up. Certainly the process is less complicated than investing in a partnership with one or more of the existing partners remaining.

The rules are simple:

• The target is entitled to a legally binding agreement from the acquisitor – the Confi dentiality Agreement – that will ensure that information obtained will be held fully confi dential, disclosed only to the senior executives, advisers and bankers of the acquisitor: these individuals and fi rms will be parties to the confi dentiality agreement. It is common practice that all documents and information obtained during Due Diligence is returned to the target if the transaction is not completed.
• The target should sign a “Stand Still” Agreement that prevents any changes to be made other than in the normal course of business. The payment of dividends, bonuses, profi t shares, the early repayment of loans and all recruitment will only occur with the agreement of the acquisitor. The target will not purchase, sell, or lease fi xed assets or engage in new contracts for supply or disposal without the approval of the acquisitor.
• The target must be open, willing and co-operative. If not, walk away.
• The Due Diligence schedule must be provided to the target in advance.
• Great care should be taken to avoid disrupting the target’s business operations or giving even the slightest hint of the deal to the target’s staff or third parties. Follow the need-to-know principle at all times.

For this reason, a Data Room may be used for larger transactions where all relevant documents are placed for review by the acquisitor and advisers. The Room may be on neutral territory or on the premises of one of the target’s advisers.
Smaller transactions may call for some document reviews overnight or at weekends on the target’s premises, to ensure confidentiality.

• The acquisitor’s staff and adviser group should be as small as is practical; thoroughly briefed on their area of study. Their reports with copies of relevant documents should be reviewed immediately on receipt by senior directors/executives, and signed off if satisfactory.

Queries that require further study should be dealt with immediately. Serious problems, once identified, should very quickly lead to a renegotiation or termination of the transaction to reduce waste of time and costs.

The Essentials – Select Good Advisers

Choose firms of solicitors and accountants with strong commercial experience; if necessary, visit several different firms to hold a ‘beauty parade’ and to meet the partner who might act in the transaction. Check hourly rates and discuss a success fee relationship which allows the adviser to recover costs only if the transaction fails; but a fee above normal if all goes well.
It should be made clear that the adviser’s role is just that – to advise. The role of the principal is to heed advice, but to retain control of any negotiations and of all decisions. Many good deals have been lost due to advisers endeavouring to act as principals and win a brownie point too far.

The Due Diligence Schedule

1. Structure:
1.1 Limited Companies and Partnerships Brief history since formation, access to Company records Details of shareholders and shareholders agreements and of Partnership Agreements Minutes of board, partners and senior management meetings for last 3 years

1.2 Directors/partners contracts of employment, remuneration and benefits

1.3 Details of advisers; solicitors, accountants, brokers and insurance brokers: correspondence files for last 3 years

1.4 Bankers: schedule of loans, overdrafts, liens and guarantees

1.5 Sole Traders and Partnerships: similar information must be obtained for businesses owned by an individual that are not incorporated or functioning as partnerships.

2. Fixed Assets:
2.1 Freehold properties:
2.11 Current market values by comparison with balance sheet values Consider valuations if necessary and marketability if target’s property may be surplus to requirements
2.12 Schedule of condition
2.13 Asbestos survey, Health & Safety records and compliance
2.14 Compliance with planning consents

2.2 Leasehold properties:
2.21 Leases, rent reviews, notice periods
2.22 Values, positive/negative by comparison with balance sheet
2.23 Schedule of condition
2.24 Compliance with leasehold covenants
2.25 Asbestos survey, Health & Safety records and compliance
2.26 Depreciation policy

2.3 Other fixed assets, owned or leased to be scheduled
2.31 Computers and IT systems. Fit for purpose, compatible with acquisitor’s own. Software contracts, cost, duration, notice periods
2.32 Communications: phone systems, copiers, printers, owned/leased, cost
2.33 Vehicles: owned, leased, hire purchase, condition, fit for purpose

3. Financials
3.1 Full audited accounts for last 3 years

3.2 Monthly/quarterly management accounts for last 2 years and current year to date with forecasts for these periods

3.3 All correspondence with auditors for last 3 years

3.4 Taxation; corporation tax due

3.5 Copy VAT returns for last 2 years; VAT due

3.6 Schedule of all bank current, loan and deposit accounts. Copy statements and all correspondence with bankers for last 3 years

3.7 Obtain credit report on target

3.8 Aged schedule of debtors and creditors at last month end.

4. Client Accounts
4.1 Held wholly separate from other accounts?

4.2 Frequently reconciled? Should be monthly or rolling reconciliation. Inspect two most recent reconciliations. If none, carry out full reconciliation

4.3 When rent paid to landlords. On receipt? Days of delay

4.4 Rent arrears policy

4.5 Age analysis of arrears at 3 month intervals for last 12 months

4.6 Fee transfers from client to office accounts – daily, weekly?

4.7 Deposits:
4.71 Full compliance with the law and trade body regulation
4.72 Who holds deposits? Fully Managed, Rent Collection or Introduction only
4.73 Dispute policy
4.74 Action on deposits unclaimed at EOT or returned “gone away”. Security.

4.8 Policy on payment of contractors and other creditors on behalf of clients

4.9 Authority for payment of rents and creditors from client account. Security.

4.10 Client accounting system, IT, manual?

5. Employees
5.1 Complete organisation chart

5.2 Schedule of employees showing: Name, address Qualifications Job title First employed Job changes, promotions, including those pending Copy, contracts of employment Wages, benefits; changes in last 3 years Disciplinary actions

5.3 Former employees who left in last 3 years, reason, new employer

5.4 Outstanding claims from previous employees

5.5 Details and file on any claims made by former employees in last 3 years

5.6 Recruitment methods and policies

5.7 Control: where does control lie? Frequently the real control of a business does not lie with the titular heads of the firm, but with one or more individuals who operate within a web of information; skills and influence. These individuals must be identified and their value for the future decided.

6. Marketing
6.1 Policies

6.2 Samples of current promotional print and recent press advertising. Breakdown of marketing spend

6.3 Details, including copy contracts of PR, media agencies, web designers and portals in use

6.4 Rankings

6.5 Brand recognition

6.6 Service standards: mystery shop all branches; check phone and email response to dummy enquiries made of all branches and HO departments

7. Files and Documentation
7.1 Sales agencies: check files for current transactions and those completed during previous month. Inspect agency agreements, correspondence/ emails with vendors and potential purchasers and telephone logs. Review standard letters

7.2 Letting agencies: check a substantial sample of landlord and tenant files match with client account records. If sample throws up errors, increase size of sample to 100% if necessary. Review forms of instruction, tenancy agreements, addenda, Notices, tenancy extensions, standard letters; quality of record keeping. External functions: examine sample Inventories and Schedules of Condition, photo-video records. Review quality and method of management inspections; End of Tenancy routines and claims against deposits.

7.3 All agencies; achieve a thorough understanding of the quality, methods and standards of all customer facing activities, complaints procedures and warmth of the relationships with customers.

8. Measurement
8.1 Consolidation
Prepare a simple, straightforward consolidation table for the pro forma balance sheet of the two businesses combined using the headings:
Own business:
+ target
Adjust for net value of disposals
= Pro forma, combined value

Similarly, a pro forma profit/loss account should be calculated matching the two charts of accounts as closely as possible:-
+ target
Adjust for savings achievable
= Pro forma profit/loss account
Schedule the assets for disposal, set a timetable and determine responsibilities for achievement.
Similarly, schedule cost reductions that should result, fix timetable and responsibilities.

Add back to the consolidation the cost of training staff required.

Draw a revised organisation chart for the enlarged business, prepare adjusted Contracts of Employment and salary benefit packages effective on completion. Prepare for completion.

In the final article in this series, Practitioner plans a completion and starts an enlarged business on the path to success – all recorded in PROPERTYdrum.