Legal due diligence helps an investor mitigate risks, propose the right bid, and make a rewarding investment decision.
Due diligence is an extensive pre-acquisition scrutiny into the business of a target. Its purpose is to reveal possible risks and evaluate commercial value before a decision to invest is made. The need to carry out due diligence arises when business combinations such as acquisitions, mergers, takeovers, investments, or disposals are considered. Due diligence appraises and verifies the commercial value of a target and helps ascertain whether that target is worth investing in or otherwise.
Due diligence can be broadly classified into tax, financial and legal due diligence.
Tax Due Diligence
Tax due diligence is an investigation conducted into a target to ascertain the taxes payable by the company depending on the tax obligations and jurisdictions to which it is subject. During any business combination, it is important to conduct a tax due diligence assessment to ensure that a target is all it claims to be and to prevent a purchaser from acquiring unknown liabilities.
The scope of tax due diligence includes an assessment of the target’s tax liabilities, tax burden, and relationship with tax authorities/regulators. The outcome of a tax due diligence is the investor’s comprehension of the extent of risks associated with a target which enables the investor to make an informed decision.
Financial Due Diligence
Financial due diligence is the overall monetary assessment of the financial status and performance of a company. It identifies mitigating areas that could pose potential risks to an investment transaction. Financial due diligence also provides an investor with knowledge about a target’s assets, liabilities, and management structure. The result of conducting financial due diligence is that it allows for the evaluation of a target by an investor.
A major advantage of conducting financial due diligence is that an investor gains an understanding of the historic and actual financial position of a target, as well as insight into its financial solvency. It also analyses the ability of the target to generate profit expeditiously.
Legal Due Diligence
Legal due diligence is an investigation conducted into a target company before engaging in any investment decisions. Its goal is to establish the status of the assets and liabilities of the target, including the legal risks associated with them.
Legal due diligence aims to authenticate assumptions concerning key projections about a target’s business. It helps assess the target’s legal and corporate status while enabling an investor to make informed business decisions. The outcome of legal due diligence will, to a great extent, affect the final decision to be made by an investor when a merger, acquisition or takeover is being considered.
This article focuses on legal due diligence. Therefore, all references made to due diligence shall, for this write-up, mean legal due diligence.
Legal Due Diligence Analysis
While conducting due diligence, it is important to carefully evaluate any legal concerns that may arise to substantially jeopardize a transaction, especially details that are within the public domain. Periodically, an investor should submit questionnaires to the target that reflects every aspect of the business and regularly review the feedback provided. The questionnaire should demand information on the underlined which will help in better valuing a target:
- Incorporation documents: These include a certificate of incorporation, memorandum of association, articles of association, shareholder’s agreements etc.
- Company records: These include minutes of meetings, directors and shareholders records, annual return documents etc.
- Legal disputes: These include potential lawsuits, pending lawsuits (civil or criminal), land disputes etc.
- Contracts: These include contracts with employees, suppliers and customers, loan documentation, licensing agreements and any other contractual obligations.
- Approvals: These include government or corporate approvals, permits, licenses, etc., needed for a company to operate legally.
- Intellectual property: These include copyrights, trademarks, patents, industrial designs etc. Others include insurance policies, pension policies, employee benefits, restrictions in business and other contingent liabilities.
In addition, any factor that impacts business performance must be reviewed. Therefore, the need to conduct a thorough investigation cannot be over-emphasized as the possibility exists wherein the target can misinform the buyer.
Legal Due Diligence Strategies
Due diligence is time demanding. Therefore, a team of dedicated and committed professionals are required to carry out the task. In assembling a due diligence team, it is important to take into consideration some basic rules, such as:
It is advisable to maintaining a small due diligence team to prevent confidential information from getting out. While conducting due diligence, the team should be dedicated to conducting a complete and accurate assessment of a target.
Maintaining proper documentation is imperative. In case a target provides untrue information, an investor would be able to renegotiate the deal. When conducting due diligence, the better the efforts invested, the fewer surprises likely to emerge. Hence, this would enable an investor to propose a fair price for the deal.
Benefits of Conducting Legal Due Diligence
In conducting legal due diligence, a plethora of advantages abound. One of such benefits is that due diligence reveals all vital elements of a target’s business and creates parameters for proper pricing of the assets and liabilities of the target. It is employed to assess risks and validate financial models and any assumptions that may arise in the review process. Legal due diligence aids investors to mitigate risks, propose an accurate bid, and make rewarding investment decisions. A rigorous screening process highlights acquisition opportunities in the business of a target.
Possible Challenges During Legal Due Diligence
A due diligence team may face certain challenges while conducting legal due diligence in Nigeria. The target may delay in providing essential documents/information to the investor.
Consequently, in a bid to close a transaction, a target may misinform or provide false documents to the investor. More so, there may be a delay from government or regulatory agencies in authenticating necessary documents provided by a target.
A poorly conducted due diligence might conceal critical elements of the target that might cause underperformance, leading to heavy financial losses in future. Hence, a high level of attention and expertise should be employed to ensure that the transaction is beneficial to the investor. Therefore, a holistic due diligence evaluation is critical to the success of any business combination.