In this Q&A, recently promoted Corporate & Commercial Partner Karen Edwards continues her series on advice for businesses; answering some common questions around due diligence.

What is due diligence?

Due diligence is the process of examining all aspects of a company or business (often referred to as the ‘target’), before potentially purchasing it.

It is always prudent to investigate certain areas of a target, such as it’s legal, financial or tax affairs, so that a prospective buyer has transparency of any issues from the outset.

This article will focus primarily on legal due diligence.

Why is legal due diligence important?

Whilst a seller might wish to qualify any warranties they are giving under a purchase contract by disclosing certain issues or liabilities in relation to the target, there is no actual legal obligation to disclose any issues at all to a buyer.

Therefore, it is particularly important for the buyer to undertake legal due diligence to understand what they are buying, what (if any) potential liabilities there are, and whether they are getting ‘value for money’.

How is legal due diligence carried out?

The first step in undertaking legal due diligence is to evaluate the deal – a preliminary assessment is made of the main risks and future opportunities.

A detailed set of enquiries, covering both standard and more bespoke questions, is then submitted to the seller.

Corporate & Commercial Partner Karen Edwards, says: “There are many areas of legal due diligence that should be high on the prospective buyer’s list.

These include – employment terms, pensions, any outstanding litigation, major contracts, IT systems, intellectual property rights and many more.

These provide a full picture of what is being purchased.”

What should be included in legal due diligence?

When conducting legal due diligence, the legal adviser will also focus on key points such as:

• How good the seller’s title is;
• The target’s contracts, especially change of control clauses and consent requirements from third parties;
• Finances and securities (registered and unregistered); and
• Periodic checks at Companies House, the Insolvency and Companies List and Land Registry.

This is only a snapshot of things considered when performing legal due diligence.

Bear in mind that transparency is a must and too many unknowns could increase the buyer’s future risk.

What risks should be assessed in legal due diligence?

Risk cannot be eliminated entirely, but it can be mitigated.

For the buyer, risk assessment is all about asking the right questions and knowing where the right places are to look, which should be facilitated by the seller.

A prospective buyer should ascertain:

• How good the cash flow situation is;
• Whether there are any hidden liabilities;
• If key employees will be staying in the target;
• Whether company books/records are up-to-date;
• That any leases on premises are in order and have not yet expired; and
• What insurance policies are in place.

My colleague Hem Gujadhur has written a full article which answers even more questions on due diligence, which can be read here.

Corporate & Commercial Solicitors

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