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Legal due diligence

A legal due diligence review looks at all the legal documents a company possesses. It is important to see how these legal documents are structured and the obligations that exist for a seller. A legal due diligence review will produce the first input for the legal documents that will be used later on in an M&A transaction, the letter of intent, and the SPA (share purchase agreement). During an M&A process, legal items are important for the success of your transaction. Legal advisers will want to get a full understanding of the possible legal risks. These risks can exist in the corporate structure, assets, customer, or employee contracts, or the IP (intellectual property). Here is an overview of this legal due diligence page:

  • What is legal due diligence?
  • The importance of legal due diligence
  • The objectives of legal due diligence
  • What is really checked during legal due diligence?
  • Deliverables or reports from legal due diligence

What is legal due diligence?

Legal due Diligence is normally performed when a buyer wants to buy a company. In an acquisition, the buyer needs to have certainty about the legal status of the company and any possible legal risks it is facing. Hence, legal due diligence can be described as a process where a detailed investigation and analysis are performed to assess the possible legal issues facing a target company. A major focus in a company acquisition is the clear understanding of all the obligations of the company: pending or potential legal issues, customer and client agreements, and employment contracts.

The importance of legal due diligence

A legal analysis of the target is very important. A buyer needs to understand which legal risks exist in the company it acquires. A buyer wants to know the full legal situation and all legal issues it faces. By buying the company, the new owner will be responsible for the legal situation going forward. Hence, it is important that all potential legal issues are fully disclosed and a way to deal with them has been agreed upon. The legal due diligence report serves as a basis for the representations and warranties included later in the share purchase agreement. If the legal risks of a share purchase are too large, a buyer can go for an asset purchase. In this type of deal, the historic legal responsibility is not transferred to the buyer. In an asset deal, the legal due diligence process is normally shorter or less extensive compared to a transaction where the shares are acquired.

The objectives of legal due diligence

Legal due diligence is an important part of a proposed acquisition. When done properly, a legal due diligence review provides valuable information to further the process of an acquisition. Performing expert legal due diligence can save tremendous costs later on after an acquisition has been completed. Generally, legal due diligence has the following objectives:

  • Assess and quantify the main legal risks
  • Provide alternatives or solutions to reduce the legal risks identified
  • Get a full understanding of the contractual domain (all available contracts and the quality)
  • Get an understanding of the employment conditions and the obligations towards the employees
  • Check for any hidden skeletons in the closet (reveal legal risks)
  • See if any material legal deal-breakers come up and how to deal with them
  • Serve as a basis for the deal structure (drafting the letter of intent and the share purchase agreement)
  • Get an idea of which guarantees should be requested by the buyer in the SPA
  • Give advice during the legal post-deal phase (enforcement of indemnities)

What is really checked during legal due diligence?

Given that legal due diligence can be a costly enterprise, it is important to determine what to check. However, there is often a bare minimum that one will need to investigate. In a larger acquisition, more legal items will be investigated, often by external legal counsel. Here’s a list of items that are normally checked during legal due diligence:

  • Corporate documents
  • The legal structure of the company (including a list of all subsidiaries)
  • All types of shares (authorized, issued, and outstanding) and the owners of them. Also, the historic share transfers that have taken place
  • Articles of incorporation and bylaws
  • Minutes of shareholder meetings
  • All shareholder agreements
  • Employment agreements of the directors or officers
  • Options and other rights to purchase shares
  • List of all the land and buildings owned
  • Check of all contracts related to other major assets owned (and leased)
  • Customer issues and legal cases

Deliverables or reports from legal due diligence

The deliverables of the legal due diligence process can differ enormously depending on the size of the acquisition. Most important is that the buyer, at the start, sets clear expectations regarding the legal due diligence deliverables. The scope of legal due diligence is often a balance between quality, costs, and the level of desired information. However, a bare minimum of legal investigation needs to be conducted. The legal due diligence report describes all documents reviewed and the key issues discovered. The buyer determines the presentation of the legal due diligence findings. The buyer will want its adviser to present legal due diligence findings in a well-prepared report. In general, it is always good to have a legal due diligence report prepared so the information is available at a later stage. If you are extremely careful about the costs it can be a bullet-point list of key issues identified. In practice, we see all kinds of legal assessments being performed, especially, given that we are often active in smaller deals where the buyer is performing the legal assessment itself or with internal people from the acquiring company. For small deals, we often see that no report has been made. For larger deals, we mostly see legal due diligence findings presented in a booklet of up to 100 pages.

Information about the process of legal due diligence

Contact us for a free-of-charge brainstorming session and feedback on your legal due diligence plans. We can discuss how the legal due diligence process can best be organized. We are open to giving you open feedback about how to structure your legal due diligence process in your industry or country.

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