Due Diligence in Canada: Process, Challenges & Best Practices

Every year, Canadian businesses lose millions to deals gone wrong because of avoidable mistakes that could be solved by proper due diligence.

However, while the process aligns with international standards, Canada’s unique legal framework requires specific attention to regulatory nuances that are essential for mitigating risks and exploiting opportunities during business transactions.

In this article, we shall explore due diligence in Canada, including crucial steps, challenges, and best practices.

What Is Due Diligence?

Due diligence refers to the process of evaluating and verifying business information in preparation for a forthcoming transaction. The business information may include:

• Financial statements
• Production capacities
• Regulatory compliance records.

Proper due diligence helps businesses make informed decisions that align with stakeholder expectations, offer protection against threats, and minimise risks.

When Is Due Diligence Required in Canada?

Every proposed business transaction requires some form of due diligence to mitigate risk exposure and ensure you get the best deal possible; for example, you don’t leave money on the table.

However, some transactions warrant due diligence more than others, which are:

1. Mergers and Acquisitions (M&A): Conduct thorough due diligence when considering an acquisition, with a primary focus on the company’s financial health, legal compliance, risks, and opportunities.
2. Corporate Transactions: Doing due diligence is a standard practice when engaging in financial transactions, such as securing loans and preparing for initial public offerings (IPOs).
3. Real Estate Transactions: Review the property deeds and ensure compliance with zoning laws to identify potential legal liabilities.
4. Regulatory Compliance: Due diligence is necessary, especially in the food and beverage, healthcare, finance, and energy sectors, before obtaining permits and licenses.
5. Personnel Hiring: Employers often conduct due diligence on potential hires to verify the accuracy and validity of the information they provide, such as their educational history and past work experience.
6. Environmental Assessment: Environmental due diligence is crucial for determining the viability of land for agricultural, industrial, or residential use. It also identifies potential contamination risks that make an area uninhabitable.
7. Anti-Money Laundering: Companies, primarily in the finance sector, such as banks, are expected to conduct due diligence on funds entering and exiting their accounts to ensure they are not the proceeds of crime or being used to finance nefarious activities, including terrorism.

Types of Due Diligence in Canada

Due diligence in Canada follows a similar template to due diligence in other jurisdictions.

You should focus on various business aspects to help you assess its legal, financial, and operational health before initiating an acquisition:

• Legal Due Diligence: Helps you assess legal risks and opportunities by reviewing the company’s internal documents, including contracts, material agreements, and board meeting minutes.
• Financial Due Diligence: Audit the company’s financial statements, debt obligations, financial targets, and cash flow to determine its financial well-being.
• Intellectual Property Due Diligence: Takes stock of the company’s catalog of intellectual property, such as patents, copyrights, trademarks, and existing licensing agreements.
• Risk Assessment Due Diligence: Identify factors that could pose a risk to the company’s prospects, such as flawed internal policies and negative public perception.
• IT Due Diligence: Audit the company’s IT assets, including hardware and software. Also, check its security measures and identify inefficiencies and vulnerabilities to be addressed before or immediately after the transaction.
• Operational Due Diligence: Evaluate the production, supply chain, logistics, and customer service systems to understand how the target company operates and identify opportunities for improving efficiencies.
• Environmental, Social, and Governance Due Diligence: Review the company’s waste management protocols, pollution control measures, and emergency procedures in case of environmental incidents. We also recommend checking the target company’s corporate social responsibility efforts.
• Regulatory Compliance Due Diligence: Ascertain compliance with regulatory bodies on a federal, territorial, provincial, and local level, including current compliance gaps.

Canadian Legal and Regulatory Framework

All mergers and acquisitions (M&A) deals, business transactions, and investment ventures must comply with the Canadian regulatory system to avoid penalties and other consequences.

Let’s highlight the key legal guidelines and how they apply to the due diligence process:

Regulation	Primary Role
Investment Canada Act	Reviews direct foreign investments of over $5 million and indirect investments of over $50 million to ensure they support Canada’s economic interests.
Competition Act	Analyzes corporate mergers to protect consumers and businesses from unfair competition practices.
Securities Regulations	Govern how public companies disclose information that could affect share prices, including news of mergers, acquisitions, or other significant events.
Privacy Laws	Laws, such as the PIPEDA (Personal Information Protection and Electronic Documents Act), protect the consumer data of all parties during due diligence.

Due Diligence Requirements

The due diligence provisions in Canada vary based on the type of transaction and the industry in which the companies involved operate.

However, there are basic requirements that apply to all forms of due diligence, including:

• Document Evaluation: Ensure you have access to critical documents such as financial statements, employee contracts, supplier contracts, licences, and permits.
• Regulatory Filings: Verify the existence and validity of tax compliance reports. Also, ensure that the company complies with Canada’s employment and environmental laws.
• Background Checks: Conduct thorough checks on the target company’s vendors, partners, and existing agreements. You should also conduct evaluations on key personnel in the company.
• Third-Party Reports: Engage an independent party to conduct legal, environmental, and financial assessments for later comparison with reports provided by the target company.
• Site Visits: Organize physical visits to the target company to assess the condition of assets, identify potential risks (environmental and safety hazards), and gain insights into the company’s operational efficiency.

The Due Diligence Process in Canada

Unlike some countries, due diligence in Canada is not only a best practice, but in some cases, it is mandatory (legally mandated).

For example, due diligence is a key legal requirement during mergers and acquisitions, as well as asset transfers, between parties in the banking, insurance, and telecommunications sectors.

With this in mind, it is crucial to understand the due diligence process in Canada, particularly for companies considering mergers and acquisitions (M&A).

1. Planning

At this stage, define the scope of the due diligence process before experts begin analyzing the documents. The process involves:

• Outlining objectives, such as asset valuation
• Identifying the type of due diligence required
• Assembling a team of legal, financial, and technical experts
• Creating a due diligence checklist
• Stipulating reasonable timelines
• Defining the responsibilities of key participants

2. Information Gathering

Next, the collection and storage of relevant documents are conducted in a secure room with limited access.

• You should especially consider setting up a secure virtual data room to facilitate document sharing and collaboration.
• Typical sources of information include financial records, such as balance sheets and income statements, as well as legal documents, including contracts, licenses, and litigation histories.
• Other types of information essential to the due diligence process include operational data, such as employee records, partners, and supply chain details; environmental impact assessment reports and permits; and IT infrastructure and cybersecurity protocols.

3. Analysis and Verification

You should then thoroughly examine the gathered information to identify risks, spot inconsistencies, and pinpoint areas for growth.

• Some key tasks in this step include financial analysis to determine whether the reported profits, debt repayment schedules, and revenue trends show long-term viability, and legal review to check for pending lawsuits and review contract obligations and intellectual property rights to ensure compliance.
• Additionally, conducting compliance checks will help you evaluate adherence to tax, labour, and environmental laws, while an operational assessment will audit the company’s operational efficiency, scalability, and workforce stability.
• Lastly, conducting a market analysis will help determine the size of the customer base, identify competitors, and assess growth potential.

4. Risk Assessment

At this stage, utilize the information gathered during the analysis stage to identify red flags and calculate associated risks.

• Examples of red flags include pending legal disputes, non-compliance with regulatory requirements, signs of financial instability such as frequent late bill payments, and inadequate cybersecurity protocols.
• After your team concludes the assessment, they should categorize each risk based on its severity and potential to cause significant damage or losses that could hurt the company’s market value in the future.

5. Reporting and Recommendations

The next step is to compile the findings into a comprehensive due diligence report. This document should contain:

• Risk parameters
• An executive summary
• A detailed finding by category
• Possible solutions for mitigating risks
• Advice on the decisions the negotiating team should make regarding contract drafting and post-transaction integration

6. Post-Transaction Follow-Up and Monitoring

Once the merger or acquisition receives approval, the due diligence team will shift focus to monitoring the acquired company’s performance. The goal will be to identify underlying risks and develop effective strategies to address them. Possible measures may include:

• Revisiting existing contracts and updating policies.
• Performing periodic assessments.
• Renegotiating on pending transactions.

As you can see, the due diligence process in Canada is very similar to that in other jurisdictions. The main challenge, however, is complying with relevant Canadian laws and regulations.

When you work with us at JS CPA Strategic Solutions, we can help identify and verify the right acquisition targets to maximize your financial gains. Other times, we may advise you to walk away from a risky merger and protect your capital.

Book a one-on-one call with our team today to get started.

Common Challenges and How to Avoid Them

Due diligence can make or break a deal, and for this reason, the process should be systematic and thorough.

So, you must watch out for common pitfalls that could cause you to miss out on red flags or underlying business risks:

• Inadequate Communication: When you have multiple teams working independently to conduct legal, financial, and regulatory checks, you will experience some communication lapses. Mandate that all due diligence teams meet regularly, ideally on a weekly basis, to discuss progress and align their goals.
• Time Limitations: Tight schedules imposed by management often cause the due diligence team to overlook some details, which could be costly in the future. On the other hand, prolonged due diligence can cause tension between the buyer and seller, thereby jeopardizing the deal. Set realistic timelines and milestones to avoid rushing the process and communicate effectively with the seller to minimize frustration.
• Jurisdictional Intricacies: Although federal regulations are consistent throughout Canada, each province and territory has its own set of rules that can complicate and prolong the due diligence process. Partner with an M&A advisory firm for expert guidance on the Canadian due diligence process.
• Lack of Transparency: In some cases, sellers intentionally withhold crucial information necessary for the deal’s progress. To prevent this, you should clearly state your non-negotiables regarding data sharing to discourage the seller from withholding vital information.
• Data Privacy Concerns: Several federal and provincial laws prohibit access to consumer data without prior approval. The time it takes to receive authorization to access such data can prolong the due diligence process. You should therefore establish secure data rooms with access control measures to safeguard consumer data.

Best Practices for Effective Due Diligence

The best dealmakers don’t work harder during due diligence; they work smarter. Here are the 6 proven tips for due diligence to protect your business and save time:

1. Establish Clear Objectives: Ensure your team understands the scope and objectives of the due diligence to mitigate common mistakes, such as overlooking key details.
2. Hire a Team of Experts: Engage experts in legal, finance, and IT to handle their respective forms of due diligence. Ensure your team is thoroughly familiar with every aspect of the due diligence process.
3. Conduct Thorough Data Collection: Keep detailed records of everything your team of experts uncovers and have them write summary reports discussing risks, threats, and opportunities.
4. Leverage Technology: Use technology such as AI tools, virtual data rooms, and credentialled data access to streamline the process and minimize human error.
5. Establish Confidentiality Guidelines: Your team should share data on secure platforms to maintain confidentiality and data integrity. Additionally, ensure every party involved in the process signs a non-disclosure agreement.
6. Create a Checklist: A checklist will outline the steps to follow to achieve the objectives of the due diligence process. Additionally, tailor the items on the checklist to align with your company’s industry practices.

Frequently Asked Questions (FAQs)

If you need more information about due diligence, we’ve compiled some quick answers to questions our clients ask:

Who Usually Pays for Due Diligence Costs in Canada?

Typically, in Canada, the buyer bears the cost of the due diligence process. That includes hiring experts, ordering third-party reports, and other consultative costs.

How Long Does a Typical Due Diligence Process Take in Canada?

The duration of a due diligence process in Canada depends on the complexity of the deal. It can take anywhere from two to four weeks for a small business acquisition to several months for larger acquisition deals.

Can Due Diligence Be Outsourced to a Third Party?

Yes, you can outsource due diligence to third parties.

Most companies involved in merger and acquisition deals prefer outsourcing to specialised M&A firms to take advantage of their efficiency and expertise, while also cutting the cost of setting up an in-house team.

Conclusion

Whether you are a seasoned investor or a first-time buyer, understanding the Canadian due diligence landscape is essential to help you navigate risks and unlock opportunities.

For example, if you’re a foreign investors, you can face significant jurisdictional hurdles and data privacy regulations that could impact the due diligence process.

A safer bet would be to outsource the due diligence process to an M&A advisory firm.

At JS CPA Strategic Solutions, we assist investors seeking to merge or acquire businesses in Canada by conducting thorough due diligence and ensuring compliance with federal and provincial legal frameworks.

Reach out to us today, so we can start planning the due diligence process.