As part of the due diligence process for a merger or acquisition, the buyer performs legal due diligence on the target business. Prior to a merger or acquisition deal, it entails assessing and comprehending the legal risk associated with the target business.
The buyer conducts legal due diligence on the target company as part of the merger or acquisition due diligence method. Assessing and comprehending the legal risk associated with the target company is needed prior to a merger or acquisition transaction.
Scope of Legal Due Diligence
Corporate and Legal Structure
It is important for the acquirer to comprehend the target company’s structure. The company’s Memorandum of Association, Articles of Association, and by-laws contain this information. Understanding the target’s organisational and legal framework helps the acquirer gain a better understanding of the business, which strengthens the foundation for future investigations.
Commercial Contracts
The legal due diligence process entails examining the target company’s contractual contracts. Examining vendor contracts, distributor contracts, service contracts, rental agreements, etc. When looking at these contracts, acquirers learn a lot of useful information. For example, words pertaining to each contract’s credit duration, legal obligations such as trade secrets, or trademark or patent usage, and so on, assist the buyer in comprehending the nitty-gritty of the company contracts. As a result, it is easier to recognise legal risks in these contracts.
Intellectual Property
Patents, trademarks, copyright, and trade secrets are all examples of intellectual property. During legal due diligence, all contracts, permits, and pending lawsuits relevant to the target company’s intellectual property are carefully examined.
Employee Contracts
Salary and benefits, conditions of employment, obligations to employers, length of employment, confidentiality arrangements, pension plans, tax liability, and so on are all covered by employee contracts. During legal due diligence, the acquirer looks at major subgroups of employee contracts. This research aids in determining the target company’s risks and potential obligations to its workers in the future.
Regulatory Compliance
Regulatory compliance refers to a company’s compliance with the rules, legislation, policies, and standards that govern its operations. The acquirer must ensure that the target company is following the law and doing everything possible to comply with regulatory requirements. This is where legitimate due diligence performs its role because it is the only aspect of the due diligence phase through which the acquirer gets to examine the target company’s policies and regulatory enforcement.
Tax Aspects
During legal due diligence, the acquirer looks for red flags when reviewing tax aspects. Any kind of deferred tax liabilities, as well as ongoing government lawsuits, fall into this category. If the target company is found to be responsible under any of these, the acquirer will face significant potential liability in terms of both money and prestige.
Litigations
Litigation related to something, including tax issues, can result in a corporation losing money as well as its credibility. The acquirer must search in all directions for existing, pending, and even anticipated potential lawsuits. Customers, retailers, workers, and the government may all file lawsuits.
Health and Safety
In recent years, workplace health and safety has become increasingly relevant. It is the company’s duty to provide a safe and healthy working atmosphere for its workers. Under ethical due diligence, the acquirer examines the target company’s compliance with health and safety regulations. These requirements could range from the availability of safety equipment in factories to well-ventilated offices.
Furthermore, the acquirer must investigate any potential health and safety lawsuits that may be dangerous in the future. Sexual assault lawsuits against the target company, for example, must be resolved prior to the M&A deal.
Environment Laws
Compliance with environmental legislation has recently become a major concern. The acquirer must understand factors such as:
Is the business well within their range of carbon footprint limit? Particularly if the target company is a manufacturing unit. Is there a wastewater treatment plant in place at the company? What is the procedure for disposing of solid waste? and so on. Even if the goal is not a manufacturing business, it may be subject to environmental regulations that it must follow. It’s also a good idea to see if the goal has any ongoing lawsuits related to environmental law violations.
Before a merger or takeover, the ultimate aim of legal due diligence is to consider all existing and potential legal threats and liabilities and try to remove as many as possible.
Advantages of Legal Due Diligence
There are four main advantages of legal due diligence which are as follows:
- Opportunity to Understand Target Company
When it comes to conducting legal due diligence on a target organisation, all legal records are taken into account. Documents including the Memorandum of Association, Articles of Association, by-laws, minutes of previous meetings, non-disclosure and other legal arrangements, and so on are thoroughly examined. This aids the acquirer in comprehending the target company’s activities prior to acquisition.
- Aids Determination of Fair Price
The buyer can gain information that can help decide the target company’s fair price by legal due diligence, which is the second major benefit of this due diligence. When we examine the target company’s financial, institutional, and organisational aspects, finer details such as litigation against the company, employee and labour agreements, intellectual property details, and so on become apparent. This provides a strong starting point for negotiations between the buyer and the target company. Furthermore, this procedure would ensure that the M&A transaction is conducted at a reasonable price for all parties.
- Aids in Preparation of a Strong M&A Contract
The benefit of legal due diligence is that it aids in the identification of issues that may obstruct the closing of the transaction. When all sides are aware of potential problem areas, they will address and eliminate them during the negotiating process. As a result, they ensure that the transaction runs smoothly and without stumbling blocks.
Why is Legal Due Diligence Important?
Due diligence in legal matters is essential for a variety of purposes, the most important of which is to make informed business decisions.
- Understand Your Own Business
The term “legal due diligence” refers to an investigation conducted by one organisation on another. A legal due diligence investigation into your own business is also possible.
If you’re considering a merger or big sale, a legal due diligence investigation into your own business can be extremely beneficial. It’s crucial to know how much the company is worth before you start negotiating.
A legal due diligence investigation may also assist the buyer in gaining a deeper understanding of the company. This refers to all of the agreements that make up the whole.
- Value a Target Company
A legal due diligence inquiry will help you understand the worth of another company in the same way as it can help the company value itself.
Legal due diligence entails gathering details on a company’s agreements, properties, and possible issues in order to determine its worth.
- Drafting and Negotiations
Negotiating and writing the agreement is a big part of a merger or acquisition. The good and bad information learned during legal due diligence will aid in the negotiating process. This is so if the transaction is a merger or an acquisition.
The knowledge gleaned from legal due diligence is particularly useful in determining risk. The agreement’s drafting is time-consuming and difficult.
- Identify Potential Closing Problems
A legal due diligence could also uncover possible issues that may cause the transaction to be delayed. Before closing, there are some steps that must be completed. The information needed to compile the list is gathered through legal due diligence.
- Legal Opinion
An attorney who specialises in due diligence investigations usually conducts legal due diligence. A legal opinion will be prepared by the lawyer or attorneys based on all of the facts gathered. The selling and buying companies also conduct legal due diligence investigations. This ensures that the viewpoint is objective.
Legal Due Diligence Process
A legal due diligence investigation takes place in three stages.
- Preparation
- Investigation
- Results
The most time-consuming part of the process is the investigation or the gathering of facts.
Preparation
The aim of this stage of legal due diligence is to establish objectives and priorities. Sometimes, one overarching goal or a number of smaller but equally significant goals stand out from the rest. Time and budget constraints often limit legal due diligence investigations. It’s critical to determine what knowledge is most critical.
Investigation
A prosecutor or a team of attorneys gathers evidence and documentation during the investigation. They will be able to form a legal opinion based on the results as to whether the selling or purchase is worthwhile. The inquiry is divided into several parts.
- Establish the Big Picture: This brings us back to the investigation’s target. It is critical to organise the investigation around a central question or target. This is also a good time to explain the company’s overall structure to the prosecuting counsel.
- Provide Documents and Interviews: The length of the list of documentation and interviews required for a legitimate due diligence investigation would most likely surprise you. There will almost certainly be more documents requested than are currently needed. The lawyer’s task is to build a complete image, which necessitates detailed information collection. Make one of the senior executives available to answer questions. Interviews are a good way to get facts quickly.
Results
At the conclusion of a legal due diligence investigation, the findings are announced. In the end, the lawyer will deliver the information in the most succinct manner possible. The lawyer would also provide a rundown of the findings, highlighting the most significant findings.
The outcomes may also provide insight or opinion. The lawyer can have an opinion on the selling or purchaser’s legality.
The results can be given in written form or over the phone. This is dependent on the scope of the investigation as well as the lawyer’s and client’s preferences.
Presentation of Legal Due Diligence Investigation Findings
Only a buyer and the buyer’s lawyers are interested in the results of a legal due diligence inquiry.
The due diligence finding should be addressed in a compact and user-friendly manner to the buyer. The presentation can take many forms:
- Verbal conversation: This is an excellent tool for small transactions or for buyers who are concerned about costs.
- Memorandum: The duration and depth of this memo will vary greatly. The written contract would be longer for bigger transactions.
The presentation of the legal due diligence investigation results, in whatever form it takes, should include a description of all examined documents, an outline of key issues found, and suggestions for resolving the issues.
Conclusion
It is critical to conduct a legal review of the goal. A customer must be aware of the legal risks associated with the business they are purchasing. A consumer needs to be aware of the whole legal situation as well as any legal problems that might arise. The new owner will be responsible for the legal situation in the future if they purchase the business. As a result, it’s important that all potential legal disputes are completely reported and a strategy for dealing with them is settled upon.
The representations and guarantees contained later in the share purchase agreement are based on the legal due diligence report. A buyer may opt for an asset purchase if the legal risks of purchasing shares are too great. The historic legal obligation is not passed to the buyer in this form of transaction. In contrast to a transaction where securities are purchased, the legal due diligence phase in an asset deal is usually shorter or less lengthy.