13.2 Due Diligence in Practice 429In practice, vendor due diligence is necessary before the vendor can organise
the data room. The establishment of a data room has the advantages of minimising
disruption to target management and the vendor.
Buyer due diligence. The purpose of buyer due diligence is to avoid bad acqui-
sitions, to ensure that the target and the obligations of the vendor are what the
buyer wants to bargain for, and not to pay too much.^3
Buyer due diligence before closing thus enables the buyer to: avoid buying “a
pig in the bag” (something without seeing it first); decide what to buy (and leave
too large risks outside); decide on the necessary contract terms (seller’s represen-
tations and warranties, covenants etc); decide on price or how the price should be
determined; and find out about the existence of “deal breakers”.
The buyer will normally get an opportunity to perform a due diligence inspec-
tion on two or more occasions depending on the structure of the negotiations. For
example, prospective bidders may be able to verify the contents of the vendor’s
initial offer memorandum by means of a data room after undertaking customary
non-disclosure obligations. One or more select bidders will be given a chance to
perform a more thorough due diligence inspection before the vendor signs the ac-
quisition agreement, and a further due diligence before closing to verify that the
target is what the vendor promised. After obtaining control, the buyer may have to
perform a last due diligence in order to find out whether there are misstatements or
a breach of contract by the vendor.
Legal due diligence. The purpose of legal due diligence performed by the buyer
depends on the stage of the negotiations. The most important purpose of legal due
diligence is to discover the relevant legal framework to which the target is subject.
Towards the end of the negotiations and, in particular, after the signing of the ac-
quisition agreement, legal due diligence will also be a means to verify the repre-
sentations and warranties of the vendor. For the vendor, legal due diligence is usu-
ally part of the pre-negotiation planning exercise.^4
Lender due diligence. A bank will not commit to lending money to the acquirer
without detailed information about the transaction. Virtually all external funding
arrangements are subject to the favourable outcome of a due diligence inspection
by investors. Where the acquirer issues shares, an investment bank will perform
due diligence (section 5.10.2). Where the acquirer raises debt funding, it will be
performed by one or more of the lenders (section 20.5.2). Before a due diligence
inspection, a bank cannot be expected to promise more than a vague commitment
letter (section 20.5.2).^5
Structure and contents of due diligence. Generally, the structure and contents of
due diligence inspections depend on three things: objectives relating to the man-
(^3) For an example of buyer due diligence, see Bainbridge SM, Mergers and Acquisitions.
Foundation Press, New York (2003) pp 177–179.
(^4) See, for example, Vandrill R, op cit, pp 291–292.
(^5) Diem A, Akquisitionsfinanzierungen. C.H. Beck, München (2005) § 2 number 22;
Cranston R, Principles of Banking Law. Second Edition. OUP, Oxford (2002) pp 301–
303.