LEGAL DUE DILIGENCE IN DIVERSIFICATION

In today’s market no matter which field you are in, it’s becoming increasingly important to diversify. As more suppliers enter the market, competition on the supply becomes higher forcing suppliers into diversification. The life cycle of businesses makes diversification inevitable. For the market leaders the need to diversify is felt when the company attains its point of maximum growth and no more profitability can be attained. For smaller and upcoming companies the need to diversify is felt when there is very high competition in a particular market, forcing it to diversify.

 

There are several reasons businesses diversify including increasingly profitability, increasing competitiveness and value, survival and expansion. Sometimes the reason for diversification could be for survival as demand for the core business is no longer there. Many businesses have been able to re-invent themselves over the years as consumer needs change by diversifying.

 

Whatever the reason for diversifying it is almost inevitable that your business will have to diversify some day if you hope to survive or expand. It’s however prudent to time your diversification well as the best time to diversify is when your core business has stabilised and also when there is good opportunity for diversification. There are many diversification strategies ranging from the very simple to very complex strategies.  The most simple diversification strategy is by natural progression and that is by offering services/ products that are directly related to your core business. In my field, which is legal professional services, many real estate lawyers are now diversifying into offering real estate services as well. Many real estate lawyers are in the business of estate agency, property management and other real estate services. The lawyers who are much diversified have gone into real estate developments and left legal practice altogether. A more complex way of diversifying is by taking advantage of a strong brand to enter into a new market. There are many opportunities created by new laws and other changes in certain markets making it possible for a strong brand to enter into that market and survive easily. A good example of this kind of diversification was when many leading banking brands in Kenya diversified into financial advisory services many years ago.

 

Well diversification sounds simple but before deciding to diversify a number of factors must be taken into account. A market research must be done on the proposed area of diversification. Diversification should be treated like a new business line altogether and the same steps that need to be taken when starting a new business should be taken when diversifying. Among some of the important things to do is drawing up a strategic plan which lay out the goals of diversification and drawing up a diversification plan. It is important to know what capital outlay is required for diversification for example will you need a new premises or new equipment? All this must be considered before rushing to diversify. The projected cash flows must also be estimated to ascertain at which point the diversified line will start making money for you. In fact during planning stage, you may find that it may not be worthwhile going into diversification or may decide to postpone the decision to diversify.

 

A legal due diligence is very important on the proposed area of diversification as some areas of diversification would be largely dependent on the results of the legal due diligence. The first thing is to find out what laws govern the proposed area of diversification and also what proposed laws are in the line. For example a firm wishing to diversify into public transport must be aware of the new traffic laws and assess its capabilities to meet all the stringent requirements as these would have a bearing on diversification. In some lines of business, the regulation in your core business forbids you from entering the area of proposed diversification. Professional services are heavily regulated and you may find that the regulations forbid you from doing certain businesses. Therefore in this sense the regulation makes it impossible for you to diversify.

 

A business planning to diversify must also ensure that the necessary regulatory approvals are gotten to avoid falling short of the law. In most sectors it would be illegal to carry out business in that sector without getting a nod from the regulator.  For example a consultancy wishing to get into human resources consultancy should be aware of the new human resources law that requires all HR practitioners to be registered.  It is also prudent to get whatever licenses are required to enable you diversify.

 

A business wishing to diversify should also take steps to acquire statutes in the relevant field of operation and also get sample contracts and documentation from your lawyer in the relevant field.

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