What Happens If You Don’t Conduct Due Diligence When Buying a Foreign Company?
Due diligence — also referred to in legal contexts as legal review, appropriate care, or necessary caution — is a process of thorough investigation and risk assessment.
In Saudi law, the term “appropriate care” (العناية الواجبة) is officially used in the Companies Law, the Capital Market Law, and other relevant executive regulations.
In this article, we at AlSalamah Law Firm will explore the legal and financial consequences of skipping due diligence when acquiring a company abroad.
What is Due Diligence?
Due diligence refers to a comprehensive legal, financial, and operational review conducted prior to any investment, acquisition, merger, or joint venture. Its purpose is to uncover and evaluate both visible and hidden legal risks — such as ongoing litigation — to ensure the investor has full insight into the legal, financial, commercial, and operational implications of the deal.
How is Due Diligence Performed?
Due diligence typically covers the following areas:
1. Legal Review
Examining the company’s articles of association, shareholder agreements, and other foundational documents to ensure they are valid and legally sound. Also includes evaluating compliance with local laws and regulations relevant to the business.
2. Financial Review
Assessing the company’s current and historical financial standing, projected revenues, the credibility of those forecasts, and reviewing accounting assets and financial records from the past five years — offering the investor insight into the company’s future outlook.
3. Tax Review
Reviewing the company’s tax status, outstanding obligations, and ensuring taxes are properly calculated and reported.
4. Asset Review
Evaluating fixed assets and major capital equipment over a period of 3 to 5 years, including reviewing real estate holdings, mortgages, ownership policies, and usage permits.
5. Commercial Review
Analyzing the company’s market activity and positioning, estimating its market value, and confirming whether the deal adds real value to the investor’s commercial growth. This includes profitability margins, capital adequacy, cost structure, and market competition.
6. Administrative Review
Reviewing marketing and administrative expenses to confirm accurate financial reporting. Also includes examining expansion-related costs, HR structure, wage data, and employee turnover rates — and their impact on operations.
7. Intellectual Property Review
Assessing the company’s intellectual property, including trademarks, patents, copyrights, and industrial designs, and investigating whether any IP-related litigation is ongoing.
Why Conduct Due Diligence When Buying a Foreign Company?
Due diligence provides foreign investors with critical insights, including:
- The company’s legal structure and objectives
- Historical development and sustainability of its business
- Operational revenue patterns
- Capital development and financial flows (operating, investment, and financing activities)
- Key clients and customer base
- Long- and short-term liabilities
- Legal and tax positions and their implications on future operations
- Shareholder rights and equity valuation
Due diligence is essential before entering any local or international contractual relationship. It must be performed in collaboration with a law firm experienced in local and international regulations to ensure that investors receive accurate information that guides sound decision-making.
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What Happens if an Investor Fails to Conduct Due Diligence?
Neglecting to conduct due diligence before acquiring or investing in a company can lead to severe consequences, including:
• Hidden Liabilities Post-Acquisition
The buyer may later discover significant debts, unresolved lawsuits, or pending tax issues.
For example, the investor might find out about a multimillion-dollar compensation claim or a serious environmental violation that was never disclosed.
• Legal and Regulatory Risks
The target company may be in violation of foreign licensing requirements or may be relying on contracts that are legally unenforceable.
• Intellectual Property and Asset Disputes
Ownership of key IP assets or real estate may be unclear or contested.
• Fraud or Accounting Manipulation
Without thorough financial due diligence, the investor could be misled by inflated profits or false accounting data.
• Overvaluation and Financial Loss
Post-acquisition, the investor may realize that the company was significantly overvalued, leading to investment failure and losses.
Case Study: HP’s Acquisition of Autonomy
One of the most notable global cases of failed due diligence was HP’s acquisition of UK-based software company Autonomy.
HP paid $11.7 billion for Autonomy — a 66% premium over its true market value. This led to a 20% drop in HP’s shares and a 70% rise in Autonomy’s stock.
A year later, HP revealed major accounting irregularities in Autonomy’s records, prompting significant financial losses and tax issues. HP filed a $5 billion lawsuit against Autonomy, accusing it of inflating revenues and evading tax. The case led to a decade-long legal battle in both the UK and US, culminating in the extradition of Autonomy’s CEO Mike Lynch to the U.S. in 2024 for fraud charges.
Due diligence is a non-negotiable legal and financial safeguard for any investor. Ignoring this step amounts to a grave oversight and may result in financial loss, litigation, and reputational damage.
Therefore, when acquiring a foreign company, it is essential to work with a specialized international law firm in the target jurisdiction.
At AlSalamah Law Firm, we offer specialized legal advisory services for conducting due diligence.
With over 10 years of experience, our team of legal professionals provides deep expertise in local and international legal frameworks to support investors in making informed, legally sound investment decisions.
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