One of the most important aspects that a lot of businesses neglect while discussing the terms of a possible acquisition deal is carrying out due diligence. Carrying out legal due diligence is seen as a burdensome exercise, and something that can cause delay in closing the deal. Though a little burdensome, carrying out due diligence is of paramount importance.
Legal Due Diligence
One of the most important steps when preparing for an M&A is carrying out legal due diligence. This is to review the strengths and weaknesses of the target entity, and to identify risky items, be it in terms of finance or legal matters. In other words, the main intention behind carrying out legal due diligence is to gather all the latest information about the organisation as well as look for any ‘red flag’ items that you were previously unaware of, that might affect the deal. A review will typically consist of a financial audit, as well as legal study of the business, to highlight any potential risks that might affect the acquisition. Some organizations may also opt for other reviews such as corporate policy, taxes, licenses, etc.
The main focus of a legal due diligence will be the legal structure of the target entity. This includes all kinds of documentation, powers of attorney, business agreements in binding, currently enforced contracts, assets, liabilities, repayment structure of debt if any, etc. All in all, a due diligence review should ideally cover every aspect of the business, in order to gain insight into the structure of the business, and uncover any irregularities.
It is essential to conduct a focused and efficient review and it is not necessarily required to cover all the legal and contractual aspects of the business. It is more likely to cover the most important aspects of the organisational structure and business of the target based on the nature of transaction (acquisition, disposal merger, etc.) as well as the nature of the business of the target (which can be retail, telecom, construction, and so on).
In each case, there will be a direct correlation between the transaction value and the extent of due diligence. A company will not spend a huge amount of sum of money on an extensive due diligence, if the company which it is acquiring have a small purchase price. But, if there is huge sum of purchase price involved, a company would like to have an in-depth research about the company in proportion the value of transaction.
For instance, if the target company is in telecom industry, the due diligence process will focus on the reviewing the licenses, agreements and other arrangements with the suppliers as well as the review of physical condition of the assets. On the other hand, if the target business is in service based industry, more stress will be given to the expertise and the competence of the employees and their practices.
In a standard sale and purchase transaction, it is the responsibility of the seller to make available all documents that will be required in a typical due diligence review. If the prospective seller does not co-operate in providing access to documents, the review process can be dragged for an unnecessarily long time. It is imperative that both parties agree to a due diligence review, and the extent of each party’s obligations in the due diligence phase.
There are no definite timelines and it varies in each case. It is mostly dependent upon the amount of documentation and information that needs to be verified. It is the responsibility of the seller to provide access to all the necessary documents and provide answers to all the questions of the purchaser and extend full cooperation in the review procedure to make sure that the due diligence process is completed in a timely manner.
In some cases, the parties split the whole due diligence process in various phases so that they can fix the milestone for the completion of each phase and the progress of the whole process can be reviewed from time to time.
Conducting due diligence review has quite a lot of benefits for both parties involved. The main benefit of a due diligence review is that the commissioning party gets to assess the rights, dues, liabilities, obligations, legal structure, etc. of the target entity or target group. Of course, in a standard sale and purchase transaction, a due diligence review is beneficial to the purchaser because it helps evaluate all aspects of the business, including financial and legal aspects. This helps the purchaser evaluate and nullify any risks.
Due diligence review also helps the purchaser quote a good price for the purchase. For example, if the lawyers of the purchaser find some kind of a liability which puts the seller in a bad position, the purchaser can negotiate a better price for the transaction. If the seller conducts a review beforehand, they can either deal with the irregularities, or prepare a good justification for their existence, thereby softening their impact on negotiations.
It is essential to undertake the Due diligence process is all the cases of M&A transactions. The review helps the parties to take the informed decisions based on the true facts of the target company. It helps in mitigating the risks involved in the M&A transactions.