If you won’t buy a bike without a test run, don’t sell the company without a proper audit

Triniti

While conducting a larger transaction there are several aspects to which attention should be paid. The most important of these aspects from which all others stem is the object of the sale. And in the case of the object of the sale it is important that both the buyer and the seller understand in the same manner what is being bought and sold. Differences concerning this matter give rise to most of the disputes and claims. Even when buying a bike, it must be thoroughly examined and taken for a test drive. All the more so, major share transactions or real estate transactions should be self-evidently accompanied by a thorough audit. Here are some ideas about conducting such an audit from the seller’s perspective.

What kind of an audit are we talking about?

Risk minimisation both for the buyer and the seller through an in-depth due diligence analysis is customary when selling a company. There are different audits conducted in this process: financial, legal, tax-related, environmental and management analysis, etc., depending on the purpose of the transaction, the object of the transaction and current circumstances. During such audits it will be established what kind of risks the acquisition of a company may entail, so that on the one hand, the buyer is given certainty with respect to the content of the object of purchase (and the price is adjusted, if necessary) and on the other hand, the seller’s risks are mitigated.

Why is an audit important for the seller?

The most important benefit for the seller upon conducting an audit is the mitigation of risks resulting from the transaction – everything found and declared in the course of the analysis and notified to the buyer can be deemed to be the buyer’s knowledge already before entry into the contract and the seller shall not be liable for this after the transaction. In other words, the buyer cannot claim that the buyer’s knowledge of the business being bought was different and the thing that was sold by the seller is not at all what was agreed upon. If the buyer thereby does not conduct the audit with sufficient thoroughness, although the information has been delivered to the buyer and the delivery has been recorded, this will be the buyer’s problem. Just like in case of the bike – if it is written already in the ad that the bike does not have a saddle, then this cannot be demanded after the bike has been bought.

In addition to the above, the audit has more benefits. There are cases when the seller also gets a better overview of the seller’s business and can consequently price the transaction better. If the risks related to possible acquisition are mitigated during the audit, this will have a positive impact on the price.

The materials that are re-examined and disclosed in preparing the audit create an opportunity for the buyer to eliminate the deficiencies that have become apparent and thereby avoid their impact on the transaction which may involve the decrease in the price or simply an annoying clause to negotiate. This can be a domain or patent which has not been renewed, some outstanding fee or partial agreement which has not been laid down in writing. Only one telephone call to a cooperation partner may be sufficient to eliminate some deficiencies which are important for the buyer and the whole transaction process is simpler and more effective.

A well-prepared, thorough and comprehensive audit will make the buyer feel that the company is well managed, operational and everything is correct and professional. However, a reverse situation may give rise to ample doubts and give a very bad impression even if everything is actually in order. Although being an emotion, this will once again affect the whole transaction.

How to conduct an audit?

1.       A competent team is the key

As usual, the result largely depends on the people who conduct the audit. In order to carry out an audit, a team should be created that consists of a sufficient number of people from within the company and some sufficient capacities from the outside. The internal team should cover the main business trends and people who have good command of the document management system being used. Internally it is a good idea to consider who should know about the transaction and who may learn about it accidentally during the audit. Answering questions should also be planned – how to distribute the questions received and who will answer the question. An external team should bring along experience – in which manner to disclose the documents, which documents should be disclosed, etc. Involvement of an external adviser helps to identify the problems described above which should be eliminated during the audit and offers simple solutions how to eliminate them. An external team depends on the number of required audits and complies with the specific nature of the company’s business. It could certainly contain a law office with transaction experience that can also recommend who could carry out financial, technical, environmental and other audits.

2.      Create structure

In order for the audit to be sufficiently comprehensive and all inclusive, it is useful to assemble the documents on the basis of an agreed structure. An adviser can offer such a structure, but just in case, it is good idea to think whether something important additionally follows from the specific nature of the company. The most important legal documents which should be definitely assembled are:

  • Large-scale contracts and contracts with bigger cooperation partners/customers;
  • Important contracts, conditions and circumstances in terms of the specific nature of economic activities – the financial volume of such activities need not be high, but for example, the existence of some software may be very important for operation;
  • Contracts containing provisions on the change of control; for example, according to the contracts entered into with banks, they shall be given an advance notice of the change of ownership or even an approval has to be obtained;
  • “Minor peculiarities” – documents and orders which are not customary. The procedure for using cars and bonuses systems, etc., are always of interest.

The above is certainly not a comprehensive structure for conducting an audit, but rather an additional place of thought worth considering besides the audit structure.

3.      Consider an audit conducted by the seller

So that everything mentioned above would go smoothly within the desired timeframe it is worth considering the so-called vendor due diligence, i.e. an audit is conducted by the seller to map any existing risks and prepare the buyer’s audit.  During this, the existing documents are not simply assembled, they are also examined by a third person, and proposals and solutions are made how to easily eliminate the deficiencies.

In conclusion, no one wants to buy or sell a pig in poke, the thing has to be properly examined before buying it. In case of a big transaction, the due diligence audit constitutes such an examination. In order to conduct it comprehensively and properly, the TRINITI transaction team gladly offers its assistance.

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