Due diligence is the term to describe the investigations into a business carried out by a purchaser before buying a business.

The process revolves around the vendor providing a large number of documents relating to the business and (when required) access to management and premises. The documents are inspected by the purchaser and its advisors. Much of the documentation is usually legal documents, such as leases and contracts, and these are inspected by the purchaser's solicitors. The due diligence documents may also include financial documents, which are usually inspected by the purchaser's chief financial officer and/ or external accountants.

Due diligence also includes carrying out searches of publicly available records, such as the records held by ASIC for a vendor or company, or records relating to the registration of business names and trademarks.

Where the sale proceeds by way of sale of shares in a company, due diligence involves investigation both of the company and of the business.

Due diligence is sometimes carried out before exchange of contracts, sometimes after exchange of contracts, and sometimes both before and after. The types of due diligence carried out before and after exchange of contracts are quite different.

Due diligence before exchange of contracts can have different purposes, as follows:

The contract will contain warranties that matters with the business are generally in order and certain minimum standards are satisfied. This is subject to anything disclosed before exchange of contracts. The vendor will wish to disclose any matters which would otherwise be a breach of a warranty. Otherwise, the purchaser could terminate or claim damages if those matters are discovered after exchange of contracts.

The vendor may also be required by law to provide information to a prospective purchaser before the contracts are signed. For example, a vendor of a small business in Victoria must give a statement to a purchaser before signing a contract or accepting a deposit.

The purchaser and its advisers search and inspect documents to enable them to decide whether to proceed with the purchase, including whether the price is fair.

See Due diligence before exchange.

When due diligence is carried out after exchange of the contract, the purchaser's solicitor will confer with the client and other advisers to determine a list of the matters that need to be investigated, to ensure that the purchaser is getting what they bargained for. This list will be the basis of the documents which the purchaser's solicitor will require from the vendor.

The process is then that the advisers go through the documents to check that they are in accordance with the contractual warranties. For example:

• check that the important contracts have been properly executed, are enforceable and any duty on them has been paid; and

• if the transaction is the sale of shares, the purchaser’s accountant will need to check that the financial records have been property kept, that the tax returns, BAS documents and other returns have been properly prepared and lodged.

The enquiries the purchaser’s solicitor is required to carry out will differ from business to business. The main point of the enquiries is to determine that the assets being sold are not subject to any registered encumbrance. It is also to check the registration of any property which requires registration, such as trademarks, business names, patents or real property leases, in states where they are registered.

Due diligence requires the vendor to provide documents to the purchaser. These will often be commercially sensitive, which could help the purchaser to compete with the vendor, if the sale does not proceed. For this reason, the vendor will require the purchaser to sign a non-disclosure agreement. This requires the purchaser not to disclose any of the information provided, nor to make any use of it, otherwise than for the purpose of the proposed purchase.

Issues may also arise if the documents themselves have provisions preventing disclosure to third parties — the consent of the parties to the agreement may be required before disclosure.

See Due diligence after exchange.

Due diligence has traditionally been carried out by the vendor collating the relevant documents and placing them in a room, to be inspected by the purchaser and its advisors.

In recent times, these physical data rooms have largely been replaced by online data rooms. The documents are scanned and loaded onto a website, with the purchaser and its advisors having access by use of a password.

There is a tendency to load too much data into the data room. Supplying too much data can be as uninformative as not supplying enough.

See Data rooms and online due diligence.