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Due diligence

angelika.rapala

Companies offering different types of innovations often look for financing options for their Startup. The most common way of getting funds for new technologies is signing  an investment contract + giving the shares in the company to the investor. In order to gain a potential investor, apart from preparing a presentation (so called „pitch”), investor requires carrying out a comprehensive analysis of the Startup`s activity (which is aimed at reinforcing the company`s credibility and establishing realistic evaluation of the project) – so called “due diligence”.

An example:

Jan K. runs X Sp. z o.o. (limited liability company, LLC) together with partners. They would like to introduce a new mobile application to the market with advertisements for the builders.

Because of the lack of sufficient funds, Jan K. asked a big company offering building materials to invest in the application.

The investor liked a concept of the application because he noticed that it can be a new sales channel and offered his financial support for 40% of the shares in the X sp. z o.o. However, in order to minimize the risk, investor laid down an additional condition – carrying out a legal and financial analysis – that is  due diligence in the company X Sp. z o.o.

Being decided to sign the contract Mr. Jan K. undertook  himself to collect all the legal and financial documentation and to have it verified by lawyers, and to make proper statements.
During the analysis of the prepared and disclosed by Mr. Jan K documents of his company, some mistakes have been found, e.g. it turned out that appropriate resolutions of the company`s bodies had not been taken regarding the purchase of the equipment in the amount above PLN 50,000 and the copyrights had not been effectively transferred on the company within the agreements with the collaborator who was fired 6 months ago. These mistakes, unnoticed in time, could have had a huge impact on the Startup`s evaluation, including its „business” credibility, by the investor. Remember that every company is treated as a so called professional entity, which is obligated to know the law and to respect it! It doesn`t matter if somebody operates for a long or a short time on the market. Thanks to the analysis of the documentation it was possible to notice what was needed to be changed or what was possible to be changed, and to prepare adequately the company for the meeting with the investor.

Due diligence helps to make a decision and to plan actions before making any strategic capital transactions, and has an influence on the running of the company after the conclusion of the investment contract. The company`s analysis is about collecting detailed information regarding its functioning.

It is recommended to carry out due diligence analysis,  especially, if you want to:

  1. sell the shares in the company,
  2. sell, transform or carry out a merger of the company,
  3. sign an investment contract.

The scope of due diligence may vary, and it is good to agree with the investor what range
of due diligence does he expect from the Startup before the work starts. This step enables
to avoid misunderstandings and unnecessary expenses for the analysis which may be irrelevant for the investor and decision- making process. -.

Due diligence may involve, for example:

  1. a legal analysis (legal due diligence),
  2. a financial analysis (financial due diligence),
  3. a tax analysis (tax due diligence).

There are also specific types of due diligence distinguished on the basis of the subject
of the analysis: a business one, a financial one, due diligence within the sell and marketing area, a labour one, the accounting system`s one and a due diligence of a circulation
of the information in the company, due diligence of the asset management and of the risk management of the company etc.

            Reports from due diligence may cover the analysis of:

  1. the company`s documentation,
  2. ownership structure and capital links,
  3. commercial documentation, terms of use, contracts concluded, general templates used,
  4. workplace regulations, collective agreements, internal regulations, employment
    and management contracts,
  5. legal status of real estates possessed by the company,
  6. IP rights (registered trade marks, patents, licences, agreements, copyrights agreements),
  7. the court proceedings, both judicial and administrative ones, in/to which the company participates,
  8. the financial situation of the company with reference to financial statements, accounting documentation, receivables and public – as well as private-law liabilities,
  9. indication of the potential financial and business risks for the company
    and for the members of the board.

Due diligence is recommended for all companies. Startup planning to look for the investor should have in mind that due diligence analysis is usually an inevitable complex process, especially when the entrepreneur doesn`t complete the appropriate documentation.

Decision regarding carrying out of due diligence, taken with reasonable time in advance,
will enable to bring the company to the point where a potential investor will have no doubts that it is worth financing.

Magda Judejko

(lawyer/event manager in SWLEX),

kancelaria@swlex.pl

Article translated by Katarzyna Wiśniewska (Attorney-at-law at SWLEX)