What is legal due diligence?
The potential buyer of a company or other property, or the potential investor in a company, will want to carry out investigations and make enquiries about what it is acquiring or investing in. This process is called due diligence. Depending on the subject matter of the transaction, the due diligence will include commercial, financial (including tax) and legal due diligence.
In the case of an investment transaction, an investor will want to carry out commercial, financial and legal due diligence on the company and its business. The scope of due diligence will vary depending on the nature of the business, the breadth of its activities and how long the business has been carried on. The due diligence required for a start-up business should be simpler than the due diligence for a business which already has a trading history.
Important areas for legal due diligence prior to making an investment include the company’s share capital, its existing contracts with customers, suppliers and employees, legal compliance and any legal disputes, ownership of key assets and intellectual property.
The legal due diligence process involves the investor (or its advisers) asking the company a list of questions for the company to answer and, where appropriate, to supply copies of relevant documents. The investor will then ask any necessary follow-up questions.
How are issues arising during due diligence dealt with?
Issues which come to light in the due diligence process can then be dealt with in a number of ways:
renegotiation of investment terms: the terms of the investment may change, for example by the investor seeking a reduction in the company valuation
pre-conditions to investment: the investor may require the company to carry out certain pre-investment actions, such as obtaining any missing legal consent or the assignment to the company of intellectual property or other assets used in the business
warranties or indemnities: specific warranties or indemnities in the investment documents, breach of which will give rise to the investor being able to claim for damages or loss which has been suffered
withdrawal: if the issue is sufficiently material and cannot be solved, or the parties are unable to agree terms to address the issue to their mutual satisfaction, the investor may choose to withdraw from the transaction