Legal due diligence in M&A

Due diligence can make or break an M&A deal. Legal due diligence reviews and evaluates the legal aspects of the company’s operations, finances and assets, including intellectual property, enabling both the buy and sell-side to identify potential liabilities and understand any legal risks. 

Here, we’re going to discuss the basics of this type of due diligence, how long it takes and what information needs to be gathered. Since legal due diligence occurs within a complex transaction workflow, we provide a clear checklist so you can be prepared, whether you’re buy-side or sell-side.

What is legal due diligence?

Legal due diligence is the process of collecting and assessing all of the legal documents and information relating to the target company. It gives both the buyer and seller the chance to scrutinize any legal risks, such as lawsuits or intellectual property details, before closing the deal. 

By understanding the target company and any potential liabilities, both parties can make an informed decision in the M&A transaction, and ensure the target company is accurately evaluated.

How to perform legal due diligence 

To perform legal due diligence, the following will need to be scrutinized:

• Contracts (customer, supply, operating and employee contracts and licenses)
• Leases
• Pending and potential lawsuits
• Intellectual property
• Property and tax liabilities
• Regulatory compliance
• Environmental laws
• Representations and warranties
• Organizational documents (company by-laws, limited liability agreements, stockholder agreements)

Steps in legal due diligence

1. Set the parameters for due diligence

The first step in legal due diligence is for the parties to decide on how the process will proceed, the deadlines and the format of the final report. 

2. Determine team and workflow

The second step is to determine who will be responsible for the different aspects of due diligence. Using a streamlined due diligence workflow tool can bring efficiency to the data collection steps. 

3. Collect documentation

Gathering the documentation that supports legal processes at the company can be time-consuming. Use a checklist to ensure nothing is missed. Some key aspects to consider include: 

• Which actions require board consent?
• Can policies be changed without a shareholder vote?
• Who can sign documents on behalf of the target and any subsidiaries?
• Are there any defences to a hostile acquisition?

Documents to gather at this step include all governing documents, such as board meeting minutes, certification of incorporation and so on; status of stock or ownership; information on subsidiaries, including whether they are wholly or partially owned; target company contracts, including licences, supplier contracts and customer contracts. 

4. Organise documents and distribute access

A virtual data room can help rapidly organize and share documents with the relevant teams on both sides of the deal. Using AI in due diligence, including to redact, organise and summarise information, with human oversight, reduces the time spent on this resource-heavy process. 

Sensitive information can be protected through appropriate security and levels of access. 

It’s important to review the company’s record retention policy and any mandated retention periods to ensure that these actions align with the dissemination, retention and use directions set out. 

5. Review change of control or anti-assignment clauses

A merger or acquisition can trigger an agreement to give a particular party rights, such as consent, payment or termination. Identifying any of these clauses and the related consequences is part of legal due diligence to assess the viability and value of the deal. 

Legal due diligence for the sell-side

Legal due diligence is not only beneficial for the buyer, but also for the seller. As the seller, it enables you to identify the worth of your company and prepare it for sale. This is especially crucial since nearly half of deals fail due to issues surfaced during the due diligence process. If the sell-side can perform due diligence on their own company first, issues can be identified and rectified before a buyer or investor gets involved.

The result for the buyer is a more streamlined, less frustrating process. For the seller, it often equates to a higher value deal.

Legal due diligence for the buy-side

For the acquiring company, the benefits of this type of due diligence are four-fold. First, it enables the buyer to understand the target company and its operations. This then aids the buyer to not only determine a fair purchase price but helps to prepare a strong M&A contract. 

And most importantly, with a thorough understanding of the target’s potential legal risks and liabilities, you can make an informed decision and avoid falling into hot water later down the track.

Who pays for due diligence?

The parties to a transaction will determine who covers due diligence expenses. Typically, both buyers and sellers will pay for a team of investment bankers, accountants, solicitors and other consultants throughout the M&A due diligence process. 

What does legal due diligence include?

Legal due diligence involves collecting and assessing all legal documents and information of a target company, including contracts, leases and so on. This is an opportunity for buyers or investors to assess legal risks and intellectual property details before agreeing to a deal. 

Types of legal due diligence

Legal due diligence will cover all aspects of the business where contractual agreements are used, external regulation applies or assets exist. This includes, but is not limited to: 

• Assets and property, including leases and ownership
• Banking and loans
• Ownership structures and agreements
• Employee contracts
• Operational policy and procedure
• Mandatory reporting processes
• Environmental regulation and compliance
• Any litigation pending or likely
• Taxation
• Governance structure and documentation

Why legal due diligence is so important

Legal due diligence helps to identify hidden liabilities and any clauses that could prevent a successful deal. It helps to verify and ensure regulatory compliance, similar to regulatory due diligence specifically and uncovers any ongoing or potential legal proceedings. Legal due diligence provides certainty and confidence to both the seller and the buyer that the deal is fair, transparent and properly evaluated.

How long does the legal due diligence process take?

Legal due diligence investigations take around 1-2 months. This is usually how long it takes for the buyer to complete a thorough evaluation of the business, including all the legal aspects.

The length of the legal due diligence process will depend on the complexity and scope of the transaction, the size of the target company and the nature of the buyer. Other factors that impact the length of this process include the availability of information and the efficiency of communication between the parties. 

The process can be extremely time-consuming and drag on if the seller goes into the deal unprepared. This is why always-on readiness is essential to a successful deal.

Create certainty with an M&A legal due diligence checklist

Our legal due diligence checklist lists every document and information angle to consider including when preparing for the legal due diligence process. The checklist can be adapted to suit small or large companies and a range of transactions, from capital raising to M&A. 

If you’re the seller, we recommend preparing well in advance of your business exit. There is a lot of information to collate ahead of legal due diligence and having it ready well ahead of the deal will position you to capture the optimal value for the transaction. 

Get started with a digitized due diligence checklist and an automated workflow to streamline the information gathering, sharing and reporting. Ansarada’s Deal Workflows automate due diligence for an organised, clear and easy process. 

This platform can be used by sellers to prepare ahead of sharing their key information. Buyers can create a checklist that covers everything they want to uncover about the target company. It’s free to get started, so why not start preparing? 

 

Legal due diligence FAQ

What is the legal due diligence of a contract?

When entering a relationship with a new vendor or third party, legal due diligence of a contract verifies the asset, supplier, service provider or third party meets expectations, including compliance, sustainability standards, ethical standards, quality and reliability. The contract is reviewed to ensure that it adequately ensures acceptable outcomes if any unexpected events occur. 

What are the key components of legal due diligence?

Legal due diligence key components are to review corporate documents to verify company ownership and structure, assess compliance with applicable laws and regulations, evaluate active and pending litigation, analyze contracts and agreements with business significance. The legal due diligence process helps to identify potential and actual risks and liabilities associated with a company. 

Who is responsible for conducting legal due diligence?

The prospective buyer or investor will conduct legal due diligence, using the information and documentation provided by the seller. A team of legal professionals, including corporate lawyers, will thoroughly examine the legal aspects of the potential investment or acquisition. 

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