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Due Diligence
A potential investor will carry out due diligence on the company and its business. Legal due diligence typically starts with the investor sending a request list to the company for answers and requested documents.
Due diligence scope varies depending on company size, activities and trading history. Due diligence on a start-up is simpler than for an established business.
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What is legal due diligence?
Potential buyers or investors carry out due diligence on what they are acquiring or investing in. Depending on the transaction subject matter, due diligence covers investigations into commercial, financial, tax and legal matters.
In an investment transaction, an investor will carry out commercial, financial and legal due diligence on the company and its business. The due diligence scope varies based on business nature, scope and trading history – due diligence for start-ups tends to be less complex compared to established businesses with a trading track record.
Important areas for legal due diligence in an investment transaction include the company’s share capital, existing contracts with customers, suppliers and employees, legal compliance and any legal disputes, ownership of key assets and intellectual property.
In legal due diligence, the investor (or its advisers) present the company with a set of inquiries for the company to answer and to provide requested or supporting documents. The investor will then ask any necessary follow-up questions.
The investor typically looks for warranties in the investment agreement covering the accuracy and completeness of the answers and documents provided by the company during the due diligence process. Care should be given in answering the requests, to avoid potential claims for breach of warranty and misrepresentation.
The replies and materials provided should also serve as the basis for the specific disclosures to be made by the company or other warrantors in the disclosure letter which will accompany the investment agreement.
How are issues arising during due diligence dealt with?
Issues identified during due diligence can be addressed in a number of ways:
- renegotiation of investment terms: such as a reduction in the company valuation
- pre-investment conditions: the investor may require the company to carry out certain pre-investment actions, such as obtaining absent legal approvals or transferring intellectual property or other essential assets to the company
- warranties or indemnities: specific warranties or indemnities in the investment agreement, breach of which entitles the investor to claim for damages or loss which has been suffered
- withdrawal: if the problem is significant and cannot be solved in another manner, or the parties cannot agree on terms to resolve it satisfactorily, the investor may opt to withdraw from the transaction.
