Mergers and acquisitions are sophisticated, multi-faceted transactions which are as varied as the companies involved in the transaction. Once the parties have entered into an agreement for the sale of the business but before the transaction closes, the buyer will be given time to conduct “due diligence.” Conducting due diligence is a cumbersome, complex process that is critical to the success of the transaction. The seller will be working to provide the buyer with reassurances that the deal is a good one and looking to confirm the monetary value of the target. The buyer will be looking to verify information about the target business, identify financial and legal risks associated with the purchase, and determine if the purchase price is based on the target’s true value.
During the due diligence period, the buyer will have access to the seller’s business records and information and will be able to engage third-party consultants to review that information and determine whether to go forward with the closing and/or whether additional contractual agreements are necessary to protect the buyer’s interests after the deal closes.
The buyer typically engages financial and valuation consultants to help with this process, as well as legal counsel to assist with legal due diligence. This article looks at legal due diligence and what is typically involved in the process.
The Purpose and Scope of Legal Due Diligence
The purpose of legal due diligence is to understand the legal risks associated with merging or acquiring the target business and to mitigate those risks consistent with the parties’ business goals and objectives. The scope of legal due diligence is unique to the deal and is dependent on the type of business being sold. It is common, however, to gather and review the following during legal due diligence:
- Organizational documents such as by-laws, operating agreements, and stockholder agreements;
- Existing contracts, including but not limited to, lease, loan, financing, license, employee, consultant, supply, equipment, and customer agreements;
- Real property records;
- Intellectual property records;
- Tax liabilities;
- Operational policies and procedures;
- Insurance policies;
- Anticipated, existing, and settled litigation;
- Court orders and judgments, arbitration awards, and administrative orders;
- Regulatory laws and compliance, including those applicable to data and privacy security, and the environment; and
- Accuracy of representations and warranties found in the purchase and sale agreement.
The Legal Due Diligence Process
Hire an M&A Attorney.
It is important to hire an attorney as soon as negotiations between the buyer and seller begin. This allows the attorney to review and negotiate key provisions of the purchase and sale agreement and to assist the parties in determining the contractual scope and timing of due diligence.
Understand the Scope and Timing of Due Diligence.
Both the seller and the buyer need to read the due diligence clause in the purchase contract, understand their due diligence objectives and obligations, and be committed to due diligence deadlines and the process, given their critical importance to closing the deal.
Establish an Internal Legal Due Diligence Team.
Working with their attorneys, each party should assemble an internal “Legal Due Diligence Team.” These are the knowledgeable individuals who will be responsible for helping to track down, assemble, and distribute documentation, and who have the authority to make determinations about deal objectives and risk mitigation through input from legal counsel.
Develop a Workflow and Checklists.
Once the legal due diligence team is identified, it should develop a workflow and create due diligence checklists and internal deadlines, which will guide and inform the process.
Gather and Organize Documents.
Gathering necessary documentation can be very time-consuming. The buyer will need to identify the documents it wishes to review and request those from the seller. Depending on the type of business involved, documents may need to be gathered from internal records, other private parties (such as banks or private equity firms), courts, and/or from local, state, and federal departments and agencies.
Document Review and Analysis.
As information is gathered, it should be reviewed and analyzed by members of the Legal Due Diligence Team and their M&A attorneys. Depending on the complexities of the deal, this too can be a time-consuming process—yet another reason to involve legal counsel as early as possible in the process. During the review process, it may be determined that specialists are needed to review certain documents.
Summarize Findings.
Once the document review and analysis are completed, the Legal Due Diligence Team will need to summarize its findings in a due diligence report or executive summary. Depending on the terms of the due diligence clause and the needs of the project, due diligence reports take many forms. A due diligence report may be a simple oral presentation, an annotated set of documents, or a voluminous written report with an executive summary. These findings are used to analyze the party’s risks and determine if additional agreements are needed to mitigate those risks.
Draft Additional Agreements, if Needed.
Based on the due diligence findings, one or both of the parties may determine that the purchase and sale agreement needs to be amended and/or that additional agreements or documentation are needed. M&A attorneys will be integral in advising their clients about the need for new agreements and in negotiating and drafting any new agreements. For example, the parties may wish to amend the purchase price or payment terms and conditions, require additional steps to be taken by the seller in advance of closing, assign ancillary or third-party agreements to the buyer, resolve liabilities prior to closing, require the seller to assume post-closing responsibility for certain liabilities that cannot be resolved prior to closing, and/or otherwise mitigate the parties’ risks.
Our Team
BHGR’s Corporate Group has successfully closed hundreds of complicated deals totaling billions of dollars in transaction value. Our attorneys represent private companies, public companies, and private equity clients across all categories of participants in transactions, including buyers, sellers, stockholders, venture capitalists, lenders, financial advisors, management, founders, investors, and private equity funds. In addition, we serve as primary corporate counsel to numerous private and public companies, giving our group an unmatched perspective on market deal points.
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[1] https://legal.thomsonreuters.com/blog/what-is-a-noncompete-agreement/
[2] https://leg.colorado.gov/bill_files/40988/download
[3] Colo. Rev. Stat. § 8-2-113 contains other exceptions to the general prohibition on non-compete agreements applicable to certain types of employees and trade secrets. It should be noted that SB25-083 made several changes regarding non-complete agreements applicable to health care employees and providers, but those changes are outside the scope of this article.
[4] Id.
[5] Id.