In M&A operations, informational asymmetry between the seller and buyer is a constant. Depending on the phase of the transaction, often the only information exchanged between the parties is that disclosed during the blind teaser stage, through which business opportunities are shared without revealing sensitive and confidential information about a target company.
The pursuit of additional information, operational and non-operational documents of the business intended to be acquired or invested in, is a fundamental premise of transactions, as it is part of the objective good faith of the pre-negotiation phase and also of the sellers’ duty to inform and the buyers’ right to be informed.
However, sellers are not required to have an absolute duty to inform, but are expected, at a minimum, to share essential, reliable, and relevant information about the business. Buyers, in turn, need to act with diligence and caution that matches the standard practices of the market, in order to examine the information, practices, and documents related to the business, for the purpose of making the best decisions regarding their investment.
In an effort to reduce informational asymmetry and thus facilitate decision-making regarding the execution of an M&A operation, parties often undergo an audit procedure called due diligence.[1]
To define the degree of responsibility of each party in the duty to inform and be informed and to parameterize behaviors during the due diligence, one must analyze, above all, the buyer’s degree of vulnerability and the informational asymmetry, through the following questions, among others: Does the buyer have privileged conditions (such as specialized advisory)? Does the business present obvious defects easily perceptible by the buyer? Are relevant informations already or should they be reasonably accessible to the buyer? Does the buyer have enough time to analyze all the information provided? Is the buyer able to verify the information provided? Does the buyer take an active stance in the audit?
A properly conducted due diligence allows the buyer to: a) discharge the burden of obtaining information (as it creates an obligation for the seller to provide requested documents and information, without relieving them of the duty to inform about relevant facts, even if not questioned), and b) assess the risks of the operation and the business as a whole, notably from the legal, tax, and financial perspectives, by identifying and quantifying liabilities and contingencies, with the consequent identification of business risks, so as to adequately assess the investment and any necessary price adjustments.
Thus, the risks identified by buyers during the due diligence are typically allocated in the transaction documents in the form of representations and warranties to be made by the sellers, which may or may not trigger the payment of indemnification by the latter, depending on the presence of a pro-sandbagging or anti-sandbagging clause, for example.
Therefore, due diligence is not only an essential mechanism for reducing informational asymmetry, delimiting risks, and defining the structure and negotiation of the transaction documents, but it also provides the buyer with greater legitimacy to complain about potential information defects, and the seller with evidence of prior knowledge or consent of situations related to the business by the buyer.
By Isabel Calvario
[1] https://marinsbertoldi.com.br/a-importancia-da-auditoria-do-vendedor-nas-operacoes-de-fusoes-e-aquisicoes/ e https://idefa.org.br/guia-pratico-de-due-diligence/
