Last month’s legal brief presented 2 ways to buy a business: (1) purchase the shares of the company or (2) purchase the assets of the company. In that article I discussed a share purchase and some of the pros and cons of such a transaction. In this month’s article, I explore some of the precautions and due diligence measures so you can minimize your risk and liability in a share purchase transaction. When you buy a business by way of shares, you are buying the whole business as a separate legal entity: the good, the bad and the ugly. Typically, all assets and liabilities remain with the company. To ensure your investment is a good one, it is very important to have a solid understanding of the business you are buying. Due diligence is like a fact-finding mission and plays a key role in every share purchase. Due diligence is the process of gathering information about the business you want to buy. The goal of due diligence is to try to identify every risk, liability, opportunity and obligation that may affect the transaction. It’s a way for lawyers and their clients to gain a complete picture of the target corporation. The Purchaser can use the due diligence findings to inform negotiations, and particularly, the purchase price. Due diligence will often inform the mechanics of the transaction and establish the conditions for closing. The scope of due diligence will largely depend on the size of the share purchase. Your due diligence is going to be much more extensive in a 5 million dollar purchase than in a smaller $10,000 purchase. There are also different areas where due diligence may be required including financial, legal, commercial, environmental, tax, employment, intellectual property, etc. The type and size of business you are buying will drive the areas of due diligence you may need to cover. Your lawyer and other professional advisors will be able to assist you in determining the areas of due diligence recommended for your transaction. When buying shares in a business, due diligence often starts with basic searches on the target corporation. Common searches include:

1. Courthouse search: is the Corporation a party to any court actions or judgements that may impact its value? Do you want to buy a company involved in a lawsuit?
2. Personal Property Registry: are there any security registrations against the property owned by the corporation?
3. Bankruptcy: has the Corporation ever filed for bankruptcy?
4. Bank Act: do any lenders have security against certain assets of the company?

Other important due diligence measures include a thorough investigation of the following:

• The Corporate Minute Book of the target corporation;
• Audited financial statements of the target corporation;
• Any employment agreements;
• Any Intellectual Property (i.e. patents, trademarks, or other IP rights);
• Workers Compensation Board (WCB) accounts;
• Corporate tax returns;
• Inventory lists;
• Etc.

In extreme cases, due diligence may reveal issues about the target company that result in negotiations being terminated. Most often, due diligence findings will be used to negotiate the purchase price and the main elements of the purchase agreement. Carrying out appropriate due diligence can require a lot of time and work, but the value of good due diligence should not be underestimated. Successful due diligence ensures the purchaser’s expectations are fulfilled and he gets what he bargained for. If you are thinking about buying a business by way of a share purchase, be sure to talk to your professional advisors about appropriate due diligence to protect your investment. In next month’s article, I will discuss the other way to buy a business: an asset purchase. Happy Holidays!