When purchasing a property for the first time, you may come across terms and phrases you’ve never heard before. Once you’ve made an offer and signed a real estate contract with a seller, the term “due diligence” will be introduced to you. Due diligence is something that every buyer should understand, so before you start looking for a home. So, here’s a quick rundown of what you can expect during and after a due diligence period in real estate.
What Is a Due Diligence Period?
The amount of time that contract parties agree to provide each other to execute an audit, inspection, or further examine the facts connected to a transaction is referred to as the due diligence period.
In real estate, for example, the due diligence period refers to the amount of time the buyer has to do property inspections, obtain appraisals, secure the necessary financing, and so on.
Due Diligence Objectives
The goal of due diligence is to ensure that you have all of the necessary facts and information to make an informed decision.
For example, if you are trying to buy a piece of land, once the seller accepts your purchase offer, you will want to ensure that the information the seller has revealed about the land is correct.
You should also conduct additional research about the property to ensure that you are comfortable proceeding with the transaction.
The Importance of the Due Diligence Period.
In commercial agreements where one side agrees to buy something, the buyer will frequently wish to negotiate a good due diligence period to gather facts, papers, and information about the acquisition.
Simple deals may have a shorter due diligence period than more complex transactions.
However, if you want to buy something valuable and have peace of mind, make sure you negotiate a suitable amount of time to conduct your due diligence.
What is the Real Estate Due Diligence Period?
When purchasing a home, a buyer has a certain period of time to investigate a property in order to feel confident about the purchase. In real estate, this is known as the due diligence period.
Due diligence might take anywhere from 7 to 14 days, depending on where you buy in the United States. The time frame for inquiries is primarily determined by common real estate customs.
At this time, you should be learning everything you can about a house’s past. Your duty during the due diligence period will be to find any defects or other flaws that may cause you to reconsider the buying choice.
Because there are no second chances, you’ll want to be as thorough as possible during the due diligence period. If you discover something that requires further examination, you can extend the due diligence period.
Example of a Due Diligence Period
To better grasp the notion, consider an example of the due diligence period.
Consider the commercial real estate due diligence period.
Assume a buyer is wanting to purchase office space in a commercial building.
In this case, the buyer agrees to pay the seller $5,000,000 in order to acquire the building.
Because there are numerous parts to audit and analyze, the parties agree to a 60-day due diligence period to allow the buyer to conduct its inquiry on the property.
- During the due diligence period, the buyer does the following:
- Examine the building’s zoning regulations and rules.
- Examine commercial leases to ensure that offices are rented.
- Check to see if there have been any previous claims on the property.
- Check to see if the renters have any claims against the landlord.
- Check for environmental compliance.
- Conduct a title search on the building.
- Examine the building’s financial records.
- Have the property inspected to ensure it meets construction codes.
- Check all other material components of the deal.
After doing all of the inspections, the buyer will agree to proceed with the transaction if he or she believes that the seller’s representations were generally correct and that the $5,000,000 is a fair price.
If the buyer discovers that there are numerous claims filed by tenants against the landlord, that the building was not built according to code, that there are title concerns, or that there are other issues, the buyer may either renegotiate the terms of the sale or cancel the entire transaction.
Sample of a Due Diligence Period Clause
2.5.Cancellation During the Due Diligence Period If, before the expiration of the Due Diligence Period, Buyer determines in its sole and absolute discretion that the Interests and/or the Property are unacceptable for Buyer’s purposes, Buyer shall have the right to terminate this Agreement by giving Seller written notice of termination before the expiration of the Due Diligence Period, and the Earnest Money shall be immediately refunded to Buyer. Furthermore, in the event of such a termination, Buyer must promptly return the Property Information to Seller or verify to Seller that the Property Information has been destroyed. If Buyer does not give written notice of termination before the Due Diligence Period expires, this Agreement will remain in full force and effect, the Earnest Money will become non-refundable to Buyer except as otherwise expressly provided herein, and Buyer will have no further right to terminate this Agreement under this paragraph 2.5.
Checklist for Real Estate Due Diligence
When purchasing real estate, use this due diligence checklist to guarantee you don’t make a mistake. Remember this when you’re looking to buy a house.
- If there is a seller’s disclosure statement, thoroughly review it for any potential issues.
- Perform a general house inspection that includes radon, mold, asbestos, insects, water quality, and lead paint testing.
- Check for water penetration into the home, especially previous ice dam difficulties.
- If there is no town sewer, have your septic system inspected.
- Make certain that the property is not in a flood zone.
- Check for any violations of property lines.
- If there is an HOA, make sure it is financially sound.
- When purchasing a townhouse or condo, make certain that there are no special levies or significant anticipated cost increases.
- If you plan to buy a condominium or townhouse and have dogs, make sure they are permitted.
- Make sure there is no ongoing litigation if there is a homeowners association.
- Check for any open permits or work that should have required a building permit.
- Get an estimate of your home’s utility expenditures.
- Check to check if the property has a negative history, such as murder or paranormal activity.
- Examine the rankings of schools and neighborhoods.
- Check for any covenants or limitations in the neighborhood.
- Check to see if there are any environmental issues near the property.
- Perform a title search to ensure that there are no liens or other title issues.
- Check for any upcoming zoning changes.
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Mergers and Acquisitions During the Due Diligence Period
When a company decides to buy another company, they usually negotiate a due diligence period.
Frequently, the acquirer and the target will engage into a memorandum of understanding, a letter of intent, or some early agreement on principle that includes provisions relevant to the buyer’s due diligence.
During the due diligence period, the acquiring business will do the following:
- Obtain and examine the target company’s financial documents
- Check that all business permits and licenses are current and in good standing.
- Examine commercial contracts and customer files
- Check that the corporation owns all of its intellectual property.
- Make certain that no dangerous lawsuits or claims are pending.
- Ascertain that the target has adequate insurance coverage.
- Examine the management team’s abilities and competences.
- And so forth.
During the due diligence period, the buyer’s goal is to collect all of the material facts required to correctly price the acquisition and decide if it’s a deal worth closing.
Extending the due diligence period in M&A transactions is extremely frequent if there is not enough time, when the parties agree to grant themselves additional time to complete their task.
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What Happens When the Due Diligence Period Ends?
When the due diligence period expires, the contractual rights negotiated by the contract’s parties expire.
In real estate transactions, for example, if the due diligence period expires and the buyer does not formally back out of the sale or indicate a wish to renegotiate the terms of the deal, he or she is frequently believed to be content with the transaction.
So, in other words, the deal becomes binding and complete, and the buyer is obligated to purchase the property from the seller.
In the context of M&A, finance, and business, what occurs after the due diligence period depends on what the parties agreed to in their agreement.
Frequently, acquiring firms will include a condition that states that if they have not formally accepted to proceed with the acquisition, the buyer is deemed to have withdrawn from the transaction.
What Happens Following the Due Diligence Period?
What happens once the due diligence period is over is determined by the terms of your contract.
Following the due diligence period, there are two possible outcomes: the acquisition will go through or it will not.
If the buyer decides to proceed with the transaction, the parties will take the necessary measures to finalize the purchase and sale.
In real estate, this means that the parties must legalize the transfer of the seller’s title to the buyer, as well as the buyer finalizing its bank financing documentation and obtaining the necessary insurance.
Similarly, in the context of an M&A, the businesses will collaborate with one another and their lawyers to transfer the target’s assets to the buyer or the corporate entity’s shares, and so on.
If either the buyer or seller uses their right not to proceed with the purchase, the transaction is terminated.
Nothing else will happen in this situation.
Keep in mind that in real estate transactions, purchasers are frequently required to put up due diligence or earnest money to indicate their seriousness about closing the deal.
If the buyer cancels the transaction, he or she will forfeit the due diligence funds.
The implications of pulling out of a transaction or the costs associated with it in business will depend on the form of the agreement between the firms.
How Long Does the Due Diligence Period Last?
The length of the due diligence period will be determined by the nature of the transaction.
The parties will negotiate a longer due diligence period as the acquisition becomes more complicated.
Simple real estate transactions can have a 7-day due diligence period, whereas sophisticated M&A transactions can have a six-month due diligence period.
Is the Due Diligence Period Extended To Cover Weekends?
Looking over the conditions of your contract will tell you whether or not the due diligence period includes weekends.
If your contract specifies a 10-day due diligence period without specifying what “days” mean, you should expect it to be regular calendar days, including weekends.
If your contract specifies 10 business days, your due diligence period will not include weekends.
Can You Extend the Period of due Diligence?
If the contract you signed includes a method for extending the due diligence period, you can do so as long as you follow the contractually agreed-upon process.
If the contract does not specify how to prolong the due diligence period, an extension may be allowed if the parties mutually agree on the parameters of the extension.
Otherwise, if your contract does not allow for the extension of the due diligence period and the other contracting party does not agree, you may be unable to extend your timetables.
Due Diligence Period FAQs
Can I walk away during due diligence?
Although it is possible to walk away, it is far better to apply due diligence to understand the home-buying process, study your chosen house, and think honestly about your wants and needs before signing a contract to avoid “buyer’s remorse.”
What do you check during due diligence?
- Federal income tax returns.
- Bank statements.
- Invoices and receipts.
- A full copy of the lease.
- Leases, such as premise and equipment leases.
- Third-party contracts, such as supplier or vendor contracts.
- Sales and use tax reports.
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