You are about to sell your company and the investor has subjected your company to due diligence (see M&A Basics: Do you want to sell your company? Part 3 - Due Diligence). What to do with the findings of the Due Diligence?
Sometimes Due Diligence findings discourage the investor and stop the transaction. This happens when the risk arising from the findings is too high. For example, it turns out that the manufacturing company has to spend substantial resources to address the environmental burden or its source. Or it turns out that there have been questionable transfers of shares / stock / business / key assets of the company in the past and the ownership title may be questioned. However, the seller's approach to disclosing information about the company may also be a reason to stop the transaction. If an investor gets the impression that the seller is deliberately trying to conceal certain information, his confidence in the seller may be irreparably damaged.
If an investor identifies deficiencies in the Due Diligence process but is not deterred from buying the company by those deficiencies, the next step in the negotiations will be to address those deficiencies. Two aspects of the identified deficiencies must be addressed.
First, the parties must agree on how to proceed if any of the risks identified in the Due Diligence materialize (e.g., the Data Protection Authority fines the company for improper data processing before the transaction is closed). There are several options. If the seller is in a good negotiating position and the findings are not material, it will persuade the investor to bear the risks itself under a "take it or leave it" approach. If the parties are in an equal bargaining position (i.e., just as the investor wants to buy, so the seller wants to sell), the parties will usually agree on appropriate indemnification on a Euro-for-Euro basis, with limits on indemnification in relation to the minimum amount of the claim, the maximum amount of indemnification, the longest possible period of time for the claim to be pursued, or the degree of mutual cooperation in the creation of the claim. An extreme in favour of the investor is an agreement that the seller will indemnify the investor on a "Euro for Euro" basis without any limits. An alternative to an indemnification agreement is a downward adjustment of the purchase price without the possibility of making claims.
Secondly, it will be necessary to resolve what to do with the identified shortcomings in the future. Some of the deficiencies are easy to remedy, for example by obtaining waivers from statutory officers who did not have management contracts in place to waive the right to appropriate remuneration. Other deficiencies will take more time to remedy. If remediation is necessary for an investor to enter the company, then the problem must be addressed immediately and in a manner agreed by the parties. If remediation can wait (particularly because it would unnecessarily delay the transaction), then it is a good idea for the transaction documentation to include provisions as to when and how the identified deficiencies will be remedied. Such provisions may vary considerably. Firstly, whether it is a 'soft' commitment or a firm commitment with a penalty for non-compliance. And then who will bear the cost of remedying the deficiencies. Will it be the target company or the seller? If the costs are borne by the offeree company, will those costs be reflected in the EBITDA calculation for the purposes of the deferred portion of the purchase price? Good legal counsel can help you answer these questions.