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Due Diligence & legal due diligence of deals

Due diligence - an integral part of the company's M&A process. Further, we will review the main nuances of the legal due diligence of the M&A deal subject matter.

Why is due diligence needed?

The companies, in the course of their activities, carry out various international deals, which include mergers and acquisitions, private investments, joint ventures or strategic alliances. Comprehensive due diligence review or due diligence is carried out when a company is considering a potential purchase or the possibility of making a particular deal. Due diligence is aimed to verify and analyze a potential deal with the purpose of determining possible risks and benefits, as well as confirming all relevant facts and financial information. In the course of due diligence process, a significant amount of information is collected in all areas of business. Namely, due diligence requires an analysis of past and current results, confirmation of the accuracy of reports, an assessment of the viability of the deal (for example, M&A).

Purposeful counterparty due diligence is critical to effective research, assessment and the successful conclusion of sophisticated dealings, including international ones. At the moment, this issue is becoming more relevant than ever due to the growing atmosphere of uncertainty and new unpredictable threats to business. As the evidence from practice shows, the conduction of a comprehensive due diligence check when concluding deals is one of the necessary conditions for a positive result.

In the period of development of cyberspace, Fintech and other areas of business, which use advanced technologies, the legal assessment procedure is especially relevant, since it can also cover intellectual property items and other aspects. It is important to understand that it is much more difficult to carry out the assessment of the IP company's assets in the post-industrial space than to determine the material value of the company's assets, its real estate and other physical property items.

Due Diligence explained

Due Diligence and legal due diligence of deals allows a buyer during M&A to confirm previously undisclosed information about the financial performance, contracts, personnel & customers of the selling company. I.e., the buyer will get a complete picture of the business to be acquired. In addition, this due diligence of deals will provide objective information about a potential client in relation to:

  • joint ventures;
  • initial public offering of securities;
  • strategic alliances with partners;
  • creation of a company with minority shareholders.

Due diligence is directly related to the investor’s corporate strategy. Legal, financial and administrative due diligence will determine whether the deal meets the objectives set within the strategy.

Due diligence of a merger deal includes examining the legal status of the counterparty, legal permission to do business with regards to its current or future obligations. Moreover, due diligence procedure ensures the check of not only the well-being of the company as a whole, but also its entire corporate structure. When an investor and an investee operate in the same industry, legal assessment is carried out according to the parameters of financial, operational and managerial interaction between them.

Due diligence types

In case of M&A, the following types of due diligence are carried out:

  • Financial;
  • Tax;
  • Legal;
  • Regulatory;
  • Operational;
  • Environmental;
  • Intellectual Property (IP) verification;
  • Commercial Due Diligence;
  • IT due diligence;
  • Comprehensive check of personnel.

Financial due diligence of the company

Financial due diligence is aimed to assess the financial condition of a business (its previous and current financial performance). Financial due diligence provides forecasts for the future and considers all possible risks. A major part of this analysis is the evaluation of financial statements, assets, debts, cash flows and forecasts to determine whether they are reliable and accurate. These help the buyer to better understand the key performance indicators of the company.

due diligence

The financial information that will be considered during financial due dilligence:

  • Audited financial statements;
  • Balance sheet;
  • Cash flow;
  • Assets and liabilities;
  • Capital expenditures;
  • Forecasts.

Legal due diligence

An integral part of any M&A deal is legal due diligence, which is aimed to identify any potential liabilities of the target company. It also gives both the buyer and the seller the opportunity to thoroughly investigate any legal risks (such as legal claims or intellectual property disclosures) prior to making the deal.

Legal due diligence of the company usually involves the detailed examination of all substantial contracts, as well as partnership agreements, licensing agreements, guarantees, and loan and bank financing agreements.

Legal due diligence

During legal due diligence the following is usually checked:

  • Contracts (contracts with customers, supplies, operational and service contracts and licenses);
  • Rent;
  • IP;
  • Property and tax liabilities;
  • Unfinished and potential lawsuits and proceedings;
  • Assurances & guarantees;
  • Organizational documents (company charter, shareholder agreements, etc.)

Comprehensive tax due diligence of M&A

Tax due diligence involves the examination of taxes applicable to a business with regards to the jurisdiction in which it is located. It is important for buyers to conduct a comprehensive tax due diligence in M&A for a number of reasons. First and foremost, to identify potential tax breaches.

A comprehensive tax due diligence of businesses allows you to assess the overall tax liability of a company and the level of tax compliance, including the check of documents such as tax returns, checking information related to tax audits and agreements with tax authorities.

Tax due diligence process:

  • Analysis of the existing tax structure of the target enterprise;
  • Checking the tax compliance of the goal object for the past periods;
  • Identification of any tax risks.

Operational due diligence of international deals

Operational comprehensive due diligence covers all major operations of the target company and examines all of its manufacturing facilities and processes. In M&A deals, operational comprehensive due diligence evaluates two points:

  1. whether operational improvements can add value to the deal;
  2. are there operational risks that need to be addressed?

Operational due diligence is a type of due diligence that examines the business model and operations of the goal object in order the buyer to be able to make the decision about the acquisition of the company overseas.

This may include an overview of:

  • Work processes;
  • Supply chains and logistics;
  • Human resources;
  • SWOT analysis of digitalization;
  • Cost optimization and risk management.

Environmental due diligence

The company's environmental due diligence is a type of complex check that examines environmental risks and issues affecting commercial property.

This may include an overview of:

  • The proximity of the facility to a sensitive environment;
  • Civil structure and materials;
  • Standard methods for safe disposal of certain materials;
  • Risk assessment and operating procedures;
  • Potential contamination of soil and groundwater;
  • Compliance with environmental legal regulations.

IP due diligence

IP due diligence involves an in-depth assessment of the IP assets, which are owned by the target company. As part of IP due diligence not only the existence of IP rights is assessed, but also the extent of their protection.

Information to be reviewed includes:

  • Trademarks, copyrights & trade secrets;
  • Domain names;
  • Patents & patent applications;
  • Brand slogans & hashtags;
  • Publicity rights;
  • Software & databases.

Commercial check

Commercial due diligence (also called market due diligence) is aimed to assess the market size, market share, competitors, and potential profit in future. Commercial due diligence is also involves the assessment of  the financial viability of the deal and the likelihood of its benefit.

Comprehensive verification of information technologies

IT comprehensive verification is an audit of a company's IT infrastructure. This type of due diligence allows the buyer to assess the existing IT structures of the purpose of the deal and to identify any potential risks in the field of protection of confidential information.

Comprehensive personnel check

It covers the examination of personnel and all the documentation related to employees and management. Personnel due diligence check is necessary to identify any risks associated with employees and covers contracts, salaries, benefits and bonuses, and any problems or complaints. All personnel policies and procedures are also carefully reviewed.

Comprehensive personnel check

Company Due Diligence check: What Do You Need to Know?

Although the due diligence procedure does not have one common system, usually there are two forms. So-called Anglo-Saxon methodology, which represents comprehensive legal and financial assessment, ensuring full disclosure of information before signing an agreement. The relevant documents detail the verification procedure, as well as the rights and obligations of the parties.

On the contrary to previous methodology, majority of countries in the world use preliminary finance and legal due diligence in a less strict order with limited disclosures. Already after the preliminary deal is concluded, a more rigorous common law due diligence process follows, which results in the conclusion of a basic agreement reflecting the business relationship.

Due Diligence process

Usually, the beginning of the due diligence process is characterized by an identification stage, in which key information is requested from a potential client or third party. Schematically the process is following:

  1. Identification.
  2. Examination.
  3. Risk assessment.

In order to conduct due diligence of a legal entity it is necessary to get from seller:

  • charter documents;
  • detailed information about founders and beneficiaries;
  • description of corporate structure;
  • information about the board of directors, etc.

At this stage, due diligence under English law may also require notarization of company documents.

Verification of a private entity usually requires the provision of:

  • identity confirmation;
  • data about the source of income and the origin of funds;
  • a description of possible political connections, depending on the intended type of activity.

Afterwards, company names, the names of private entities and the names of non-profit organizations will be verified by the global sanctions lists. At the same time, an additional due diligence check can be carried out with the lists of law enforcement agencies and regulators about known criminals, banned or disqualified companies and individuals.

Also, at this stage, lists of politically exposed persons (PEP) are checked to identify government or official relationships. This process is usually automated and processes thousands of records simultaneously. Based on the information obtained during the identification process and the results of the checks of the above lists, an assessment of the respective risks is carried out.

Conclusion

Due Diligence of a merging deal of companies is a rather complicated process, so usually buyers turn to specialists. If you intend to proceed with a merger deal, please contact us in a convenient way to order legal advice on conducting M&A deals. IQ Decision UK specialized experts will advise you on due diligence and M&A regulation.

FAQ

What does “Due Diligence” stand for?

Due Diligence is a comprehensive assessment, the process of investigating or auditing a potential deal to confirm all relevant facts and financial information.

What areas does Due Diligence include?

Due Diligence of a merger deal includes the following types of due diligence: 

  1. Financial assessment;
  2. Complex verification of intellectual property;
  3. Commercial Due Diligence;
  4. IT due diligence;
  5. Comprehensive check of personnel;
  6. Regulatory due diligence;
  7. Environmental inspection;
  8. Legal Due Diligence.
How to conduct Due Diligence for M&A deals?

If you intend to agree on a merger deal, you can contact IQ Decision UK and get legal advice on conducting a security screening of the company. We can provide you with the required information and support in due diligence for M&A deals.

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