Once the fundamentals of a deal are struck, in nearly all transactions for the sale of a business (or a financing), the parties often expend significant time and energy conducting, or facilitating, “due diligence” on the target business.
The purpose of this blog post is to set out some of the basics for acquirers and vendors in completing legal due diligence for a potential acquisition, be it through the purchase of shares or assets. For simplicity, in this blog post I will refer to the assets, shares or business being purchased as the ‘Target’. While this blog post may be useful for acquirers, it will also be helpful for vendors so that they are aware of the types of questions they will be asked and the documents they will be asked to produce during the acquirer’s legal due diligence.
All businesses, no matter the size, who are contemplating a future sale will be interested in the type of information and documents that are typically sought. This is to ensure that they can be prepared and develop internal systems and procedures to ensure that they can quickly and accurately produce documentation required to streamline the transaction process for the benefit of all parties.
This blog post focuses on legal due diligence completed by your business or corporate lawyer and specialist lawyers, as necessary. There will often also be significant business and financial due diligence completed that will usually be conducted by the acquirer’s other advisors in concert with the acquirer’s own business team.
What Are We Trying To Accomplish?
The goal of legal due diligence is for the parties to use what they learn to value the Target and to locate any opportunities, and more importantly, any risks. At the most fundamental level an acquirer will be looking to:
- confirm the vendor has good title to the Target;
- locate potential liabilities or risks associated with the Target;
- verify the value of the Target;
- identify steps necessary to integrate the Target into the acquirer’s business;
- educate the acquirer about the operation of the Target;
- confirm the structure of the transaction and determine what legal documentation is needed to complete the deal correctly; and
- locate any impediments to the transaction, such as:
- third-party consents;
- a required shareholder class vote; or
- prohibitions on the transfer of a Target’s shares or assets.
The breadth, depth and timing of the legal due diligence will depend on many factors. In an ideal world, a Target could be investigated completely, and all risks could be discovered and quantified. However, the real world requires timelines to be met, costs to be constrained, and information can be missing or unavailable. These considerations will all need to be contemplated when the acquirer and its counsel are devising the scope of the legal due diligence to be completed that best meets the acquirer’s goals.
The scope of the legal due diligence required will depend on:
- deal structure (share purchases will often (but not always) require more due diligence than an asset purchase);
- industry (complexity of the industry or a significant regulatory component may necessitate more detailed avenues of due diligence);
- global or cross-border operations (cross-border expertise and advisors may be necessary when a Target has a global footprint or when assets are located in another jurisdiction); and
- costs, time and risk tolerance (all of these factors will play into what is investigated and what can be investigated within the parameters of any engagement).
At a minimum, the legal due diligence needs to confirm, with reasonable certainty and backstopped by appropriate representations and warranties, that the vendor can sell the Target and that the business or assets are sold with clear title (subject to any permitted encumbrances).
Key Diligence Requests
Depending on the industry, sophistication of the Target, and scope and parameters of the legal due diligence set by the acquiror, all vendors should expect that the following essential items will be requested:
Organizational Documents. These will include corporate articles, by-laws, shareholders agreements, and minute books.
Key Considerations: Are corporate records up-to-date? Who are the individuals who have consent rights, if any? Are there any restrictions on certain transfers, rights of first refusal or pre-emptive rights?
Public Record and Registry Searches. These searches ensure the capacity and ownership of assets or the business.
Key Considerations: Are corporate government filings showing the correct officers and directors? Are there any bankruptcy filings, court proceedings outstanding or registered encumbrances on personal property or real property of the Target?
Contracts. Contracts with customers, suppliers, licensees, licensors, franchisors, franchisees, landlords, tenants, employees, independent contractors and any other agreements material to the business or assets should be reviewed and analyzed.
Key Considerations: Who are the parties involved? Is there a limitation on change of control or assignment? How can the contracts be terminated? Do the underlying economics of the contracts make sense? Are there any special or unusual provisions that increase the risk for the Target? Are the documents actually signed and have all amendments, appendices and exhibits been provided?
Specialty Legal Review. Depending on the industry and nature of the business, a specialised legal review might be necessary for certain areas including real estate, intellectual property, environmental and pension and benefits. Outside consultants are often involved in specialized areas, including accountants and insurance advisors.
The End Result
Any legal due diligence exercise will not only affect whether a transaction will proceed or not, but it can also impact the deal structure, purchase price, representation and warranties in a definitive agreement and pre- and post-closing covenants. The ultimate product of a due diligence review is the due diligence report. Due diligence reports range from an oral presentation to a lengthy document with very detailed findings. Generally, the length and level of detail in the report will correspond with the scope of the legal due diligence review.
Acquirors and vendors should put advanced thought into the due diligence of their next transaction to streamline what is often a labourious and disruptive process. Acquirors and their consultants should be savvy enough to make detailed requests to the vendor that set out specific items of concern for them and do not bogged down a vendor with irrelevant or duplicate requests.
Vendors should prepare themselves for sale by maintaining accurate and easily accessible records that can be provided to a potential acquirer in a streamlined way.
In all events, legal due diligence sets the stage for the negotiation, pricing, and structure of a possible transaction. In a negotiated deal, all parties should work together to minimize the disruption and costs to further the business objectives of both parties.
At Mills & Mills LLP, our lawyers regularly help clients with a wide range of legal matters including business law, family law, real estate law, estate law, employment law, health law, and tax law. For over 130 years, we have earned a reputation amongst our peers and clients for quality of service and breadth of knowledge. Contact us online or at (416) 863-0125.