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Nexia Ebner Stolz

Compliance due diligence – a clear advantage with corporate acquisitions

Due diligence is now a standard component of the research that precedes corporate acquisitions, and it is impossible to imagine any M&A practice without it. In addition to performing classic due diligence, companies, banks and financial investors are increasingly expanding the focus of their examinations and conducting compliance due diligence.

Com­p­li­ance due dili­gence is really no dif­fe­rent than regu­lar due dili­gence. It just has a slightly dif­fe­rent objec­tive and the­re­fore emp­loys a dif­fe­rent metho­do­logy. More­o­ver, com­p­li­ance due dili­gence is both retro­s­pec­tive and pro­s­pec­tive in nature and thus extends beyond legal due dili­gence. The pri­mary goal of com­p­li­ance due dili­gence is to ascer­tain whe­ther the spe­ci­fic legal and eco­no­mic risks that are mate­rial to a com­pany have been iden­ti­fied and whe­ther a com­p­li­ance mana­ge­ment sys­tem with infor­ma­tio­nal, trai­ning and con­trol com­pon­ents has been estab­lis­hed to appro­pria­tely res­pond to these risks. In other words, lega­lity is not the sole focal point. The ethi­cal beha­vior of emp­loyees and mana­ge­ment also mat­ters, which safe­guards an entity’s repu­ta­tion, a cor­po­rate value with gro­wing sig­ni­fi­cance, and helps to avoid or at least reduce lia­bi­lity risks.

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Com­p­li­ance due dili­gence always beg­ins with iden­ti­fying the legal and eco­no­mic risks that are mate­rial to the tar­get com­pany. The sec­tor in which a spe­ci­fic com­pany ope­ra­tes and its indi­vi­dual cir­cum­stan­ces are import fac­tors in this regard. Is the com­pany active in a regu­la­ted sec­tor like phar­maceuti­cals, waste mana­ge­ment or ban­king? Is it a manu­fac­tu­ring enter­prise and the­re­fore expo­sed to pro­duct lia­bi­lity risks? Is it mostly invol­ved in exports? Are there any inter­nal poli­cies on issues the com­pany dee­ply values, such as environ­men­tal pro­tec­tion and social justice, that impose stric­ter requi­re­ments on its ope­ra­ti­ons than exis­ting laws pre­scribe?

Expe­ri­ence shows that the purcha­sing, sales and acco­un­ting depart­ments are the main areas of focus in com­p­li­ance due dili­gence, since lia­bi­lity risks and even cri­mi­nal risks like cor­rup­tion, anti­trust vio­la­ti­ons, fraud and embezz­le­ment that could jeo­par­dize the con­ti­nued exis­tence of the com­pany can be grea­test there. Howe­ver, staff invol­ve­ment in these depart­ments is key, so as not to give the impres­sion that all of the emp­loyees in these depart­ments are under suspi­cion. Com­pany and indu­s­try-spe­ci­fic risks like environ­men­tal lia­bi­lity or pro­duct lia­bi­lity must not be pus­hed into the back­ground. In addi­tion, many com­pa­nies today often unde­re­sti­mate the IT risks asso­cia­ted with their com­pu­ter and Inter­net usage.

Besi­des sub­stan­tive reviews, func­tio­nal reviews of an acqui­ree’s com­p­li­ance mana­ge­ment sys­tem, assu­ming it has one that is, are also part of com­p­li­ance due dili­gence. Com­p­li­ance mana­ge­ment sys­tems should be strin­gent, inter­nally con­sis­tent and cap­ture all important divi­si­ons and depart­ments. Other items to cla­rify include what kind of infor­ma­tion and con­trol struc­tu­res there are and whe­ther emp­loyees are regu­larly and appro­pria­tely trai­ned. Of great rele­vance to buy­ers is exa­mi­ning the sys­tem for weak­nes­ses that could pro­duce pre­viously uni­den­ti­fied lia­bi­lity risks. Audi­ting Stan­dard 980 of the Ger­man Insti­tute of Pub­lic Audi­tors (IDW) pro­vi­des gui­dance for per­for­ming com­p­li­ance audits. If an inves­tee has not yet estab­lis­hed a com­p­li­ance mana­ge­ment sys­tem, there may be con­cerns about its com­p­li­ance cul­ture and lia­bi­lity risks that need to be addres­sed in the purchase price or through gua­ran­tees.

The results of com­p­li­ance due dili­gence have a large bea­ring on the furt­her pro­gress of con­tract nego­tia­ti­ons and may, in the worst case sce­na­rio, e.g., with serious anti­trust vio­la­ti­ons, cor­rup­tion or pro­duct lia­bi­lity risks, cause the nego­tia­ti­ons to be bro­ken off. Even if nego­tia­ti­ons con­ti­nue, the results will be incor­po­ra­ted into the con­tract, say in the list of gua­ran­tees and war­ran­ties pro­vi­ded or in indem­ni­fi­ca­tion clau­ses. The price will also be affec­ted.

In practice, the trend away from due dili­gence focu­sed solely on legal, tax or finan­cial issues in favor of a com­p­li­ance-based due dili­gence has pro­ven effec­tive. Buy­ers get a more com­pre­hen­sive look at their tar­get com­pa­nies, redu­cing the risk of bad invest­ments and faci­li­ta­ting the tar­get com­pany’s inte­g­ra­tion into the buy­ers’ cor­po­rate orga­niza­tion. Thus, the added time and expense asso­cia­ted with com­p­li­ance due dili­gence is time and money well spent.

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