A Quick Thought On Diligence

December 20, 2023

by a professional from University of Michigan - Ann Arbor in Detroit, MI, USA

On smaller deals, searchers should focus their lawyers on drafting a comprehensive purchase agreement. Small companies typically have incomplete records. Even thorough diligence will fail to eliminate all risks relating to undisclosed liabilities. A strong purchase agreement can protect you against these unknown unknowns.

That does not mean, however, that diligence does not matter. A case in point: When recently conducting diligence, a client came across several undisclosed phantom stock agreements, material in amount.

Right-size your diligence based on the complexity of the target company and your appetite for risk. But do so with commitment and care. Caveat emptor.

Reply by a professional
from James Madison University in Washington, DC, USA

Well said. Having conducted over 100+ financial due diligence on small-medium sized business the level of diligence is entirely based on my clients level or risk & comfort with handling this area of the acquisition. A well-constructed deal team is key to achieving optimal outcomes, ensuring transactions are tailored and efficient.

Reply by a professional
from University of Michigan in Detroit, MI, USA

Good question, ^redacted‌. I cannot (which I hope says something about the quality of our representation on the front end). Strong indemnification provisions and an offset right (if available) are deterrents. And that's before you start to discuss earnouts and seller financing. The phantom stock example I gave, while real, is rare. And while initially undisclosed, it came to light and is being taken into account during negotiations. Without an attorneys' fee provision (and even then), only the biggest issues will ever see the inside of a courtroom (thank you American rule--litigants generally pay their only costs, win, lose, or draw).

+5 more replies.

Join the discussion