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What is a due diligence period in simple terms?
How does it work?
In this article, I will break down the meaning of Due Diligence Period so you know all there is to know about it!
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What Is Due Diligence Period
Due diligence period refers to the amount of time parties to a contract agree to give one another to perform an audit, inspection, or further investigate the facts relating to a transaction.
For example, in real estate, the due diligence period refers to the amount of time the buyer has to perform property inspections, get appraisals done, line up the required financing, search the title of the property, and so on.
Due Diligence Objective
The objective of performing due diligence is to ensure that you have all the proper facts and information to make an informed decision.
For example, if you are looking to purchase a piece of land, following the acceptance of your purchase offer by the seller, you will want to make sure that the information the seller has disclosed on the piece of land is accurate.
Also, you’ll want to further investigate the land to make sure you are comfortable going forward with the transaction.
Importance of Due Diligence Period
The due diligence period is very important.
Very often, in commercial transactions where one party is agreeing to purchase something, the buyer will want to negotiate a good due diligence period to gather facts, documents, and information relating to the transaction.
The due diligence period for simple transactions can be shorter than for more complex transactions.
However, if you are looking to purchase something of value and want to have peace of mind, make sure you negotiate a sufficient amount of time to do your due diligence.
How Does Due Diligence Period Work
Now that you know what is the due diligence period, let’s see how it works in different situations.
Due Diligence Period Real Estate
What is due diligence period in real estate?
Due diligence period in real estate refers to the amount of time a property buyer and seller have agreed for the buyer to perform to inspect the property and make a decision to move forward with the transaction or not.
During the real estate due diligence period, the buyer will typically:
- Inspect the property
- Get environmental inspections done
- Verify zoning rules
- Do title search
- Appraise the property
- Get financing
- Verify homeowner association documents
- Get property insurance
If the buyer’s inspection reveals that everything is fine, the buyer can decide to move forward with the transaction and close the property.
However, if the due diligence reveals issues, problems, and defects, then the buyer can either renegotiate the terms of the deal or simply back out.
Due Diligence Period Mergers & Acquisitions
In business, when a company decides to buy another company, they will typically negotiate a due diligence period.
Very often, the acquirer and the target will enter into a memorandum of understanding, a letter of intent, or some preliminary agreement on principle where they include specifics relating to the due diligence to be done by the buyer.
During its due diligence period, the acquiring company will:
- Obtain and review financial documents of the target company
- Ensure business permits and licenses are valid and in good standing
- Consult commercial contracts and client records
- Verify the company owns all its intellectual property
- Ensure there are no risky lawsuits or claims pending
- Make sure the target has the proper insurance coverages
- Study the management team’s skills and competencies
And so on.
During the due diligence period timeline, the buyer’s objective is to ensure that it obtains all the material facts necessary to adequately price the transaction and decide if it’s a deal worth concluding.
If there is not enough time, extending due diligence period in M&A transactions is quite common where the parties agree to give themselves additional time to complete their work.
What Happens When Due Diligence Period Expires
Once the due diligence period is over, then the contractual rights negotiated by the parties to the contract expire.
For example, in real estate transactions, if the due diligence period ends and the buyer does not formally back out of the deal or indicate its intention to renegotiate the terms of the deal, very often he or she will be deemed to be satisfied with the transaction.
In other words, the transaction becomes firm and final and the buyer will have the obligation to buy the property from the seller.
In the context of M&A, finance, and business, once the due diligence period ends, what happens after will depend on what the parties have negotiated in their agreement.
Very often, acquiring companies will put a provision where if they have not formally accepted to move forward with the transaction, the buyer will be deemed to have withdrawn from the transaction.
What Happens After Due Diligence Period
Once the due diligence period is over, what happens after will depend on the terms of your contract.
After the due diligence period, there are two possible outcomes, either the transaction will go through or not.
If the buyer decides to move forward with the transaction, then the parties will engage in the steps required to formalize the purchase and sale.
In real estate, this means that the parties will need to formalize the transfer of the seller’s title to the buyer, the buyer finalizes its bank financing documents, gets the proper insurance, and so on.
Similarly, in the context of an M&A, the businesses will work with one another and their lawyers to convey the assets of the target to the buyer or the shares of the business entity, and so on.
If the buyer or seller exercises the right not to proceed with the transaction, then the deal is off.
In this situation, nothing else will happen.
Keep in mind that in real estate deals, quite often buyers are required to put up due diligence money or earnest money to demonstrate their seriousness to close the deal.
If the buyer calls off the deal, he or she will lose the due diligence money.
In business, the consequences of backing out of the deal or costs associated with it will depend on the nature of the agreement between the companies.
Due Diligence Period Example
Let’s look at an example of the due diligence period to better understand the concept.
Let’s use the due diligence period in commercial real estate.
Imagine that a buyer is looking to buy a commercial real estate made of offices.
In this context, the buyer agrees to pay the seller $5,000,000 to purchase the building.
Since there are many elements to audit and review, the parties agree to a 60 day due diligence period allowing the buyer to do its investigation on the property.
During the due diligence period, the buyer performs things like:
- Review zoning laws and rules applicable to the building
- Review the commercial leases and ensure offices are rented
- Verify if there have been prior claims on the building
- Verify if there are claims by the tenants against the landlord
- Verify environmental compliance
- Perform title search on the building
- Examine the financial records of the building
- Have the property inspected to ensure it complies with the building codes
- Verify all other material aspects relating to the transaction
If the buyer concludes that the seller’s declarations were generally accurate and the $5,000,000 is a fair price after having done all the inspections, the buyer will agree to move forward with the deal.
However, if the buyer finds that there are many claims filed by the tenants against the landlord, that the building is not built according to code, there are title issues, or discovers other issues, the buyer may either renegotiate the terms of the deal or just cancel the whole thing.
Due Diligence Period FAQ
Now that I’ve explained what is due diligence period, let’s look at some of the frequently asked questions relating to it.
How long is the due diligence period
The duration of the due diligence period will depend on the nature of the transaction that you are entering into.
The more complicated the transaction, the more the parties will negotiate a longer due diligence period.
In simple real estate transactions, you can have a 7 day due diligence period and in complex M&A deals, you can have a due diligence period of up to six months.
Does due diligence period include weekends
You’ll know if the due diligence period includes the weekends or not by looking at the terms of your contract.
If your contract refers to a due diligence period of 10 days without defining what “days” means, you can expect that to be regular calendar days that include weekends.
However, if your contract refers to 10 business days, then your due diligence period will not include the weekends.
What happens after due diligence period
After the due diligence period, either the buyer will move forward with the transaction or the deal is called off.
If the buyer moves forward with the purchase, then after the due diligence period is over, the buyer and seller have to formally conclude the transaction (or “close” the deal).
This means that the buyer’s main obligation is to pay the seller the purchase price and the seller’s obligation is to convey the title to the property or asset.
If the deal is called off, then the parties simply walk away from the deal.
In some cases, the buyer or seller may back out of the deal in an unexpected or unjustified manner.
In that case, unfortunately, the buyer or seller may file a lawsuit against one another for breach of contract and damages, among other things.
Can you extend due diligence period
If the contract you signed allows for a mechanism to extend the due diligence period, then you can extend the timelines provided you follow the process contractually agreed.
If the contract does not provide specifics on how to extend the due diligence period, then an extension may be possible provided the parties mutually agree to the extension terms.
Otherwise, if your contract does not provide for the possibility of an extension of the due diligence period and the other contracting party does not agree, then you may not be able to extend your timelines.
What is the diligence period in real estate
In real estate, your typical due diligence period is approximately 10 to 14 days.
However, different jurisdictions will have different due diligence time periods in their contracts.
A 7 to 14 day due diligence period can be just fine in straightforward real estate transactions.
However, if you are looking to do a more comprehensive investigation, be sure to negotiate a longer period.
Due Diligence Period Meaning Takeaways
So there you have it folks!
What does due diligence period mean?
What is a due diligence period in real estate?
In essence, the “due diligence period” refers to a mutually agreed period of time where a buyer is given the right to perform an audit, inspection, review of the object of the transaction before fully committing to its purchase.
For example, if you are buying a used car, you will want to have a short period of time to have the car inspected at the garage before making a 100% definitive decision to buy the car.
Even though you may not call this a due diligence period, in fact the period of time you have to inspect the car is a due diligence period.
The phrase due diligence period is very often used in real estate as that’s the period of time that a buyer is given the right to inspect the property before purchasing it.
The buyer will assess the potential risks of buying and verify that it will pay a fair price for the purchase.
Now that you understand the due diligence period and how it works, good luck with your transaction!
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Understanding Due Diligence Period
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