Make Your Company’s M&A Deal Succeed with Legal Due Diligence

Due diligence is verifying the facts about something you want to buy. It’s a key step in any big purchase, and even more so when it’s your business that is looking to merge with or acquire a target company.

Because companies are complex entities, merger and acquisition (M&A) due diligence can be complicated. It’s not a process that a business owner can do alone. M&A transaction teams handle different parts of the deal.

A critical part of M&A due diligence is legal review. For this, you need to get an experienced attorney involved as early as possible.

When To Start Preparing For a Merger or Acquisition

“Every business has issues that come up in the ordinary course. No business is pristine, and as a buyer, you want to ensure those issues get put out there and addressed. The earlier, the better,” says Pete Faust, a mergers & acquisitions attorney at O’Neil, Cannon, Hollman, DeJong & Laing S.C. in Milwaukee.

“The best time to prepare to sell your business is when you’re not looking to sell your business,” Faust adds. “That way, you’re not scrambling if you receive an unsolicited but appealing offer.”

One of the many benefits of careful planning is that it helps keep things under wraps until you’re ready to make them public. “Business owners are often concerned that employees will read certain activities internally, tipping them off that something is going on. Some owners are very sensitive about that and don’t want to give the appearance that there’s a transaction in the works.”

The way to avoid this is preparation ahead of time. Keep track of important documents and keep business records in one place. “That way, you won’t signal to others within the company that there’s something afoot when the time comes,” says Faust. “Additionally, if there are any issues, it’s so much easier to deal with them earlier in the process than on the eve of closing. Rushed timing always magnifies issues.”

The Purpose of M&A Due Diligence: Buyer’s Standpoint

“From a buyer’s standpoint, the goal of the due diligence process is to confirm that the business being acquired — whether it’s a stock purchase or asset deal — matches the buyer’s expectation and that the business supports the purchase price the buyer is paying,” says Faust. “At this point in the deal timeline, the buyer has received very limited information about the business and has based a purchase price on that limited information. The buyer is looking for deal validation.”

Due diligence begins once the parties to an M&A deal have signed the letter of intent (LOI). The LOI generally determines not only the purchase price, but also the structure of the deal-making, which has huge implications for tax liabilities, says M&A attorney Nicholas Flint of Flint, Connolly & Walker in Canton, Georgia.

“At that point, it makes sense to bring in the legal and tax experts to opine on things like structure,” Flint says. “We’d rather be involved in that LOI negotiation phase because there are often some things that really are helpful to speed up and streamline the process if we can nail them down.”

Getting an M&A Lawyer Involved Before the LOI

Erica Opitz, a mergers and acquisitions attorney at Chamberlain Hrdlicka in Atlanta, recommends consulting an M&A attorney before signing the LOI.

“Although the LOI is nonbinding, I’ve seen situations where nonbinding provisions that seemed innocuous create problems later. Let’s say the purchase price language firmly states this will be the purchase price, as opposed to making it subject to due diligence and other findings. If you get into due diligence, and there’s a major issue, the other party can make the argument that this purchase price was agreed to.”

Investing in the details and documentation saves time and money down the road. “Having to defend that claim cost extra money,” says Opitz. “And when you have to pay your attorney’s hourly rate to find documents for you, time-consuming litigation increases the cost of the transaction.”

For a small or family-owned business, Opitz says, “We typically recommend they get us involved when they first start thinking about taking offers and market position for the company, so we can help them clean up their corporate records and bookkeeping. We don’t want anything to come up during due diligence that spooks the buyer.”

Preparing for M&A Due Diligence: Seller’s Standpoint

From the seller’s standpoint, the strategic goal is to ensure that all key information about the business is readily available to conduct the M&A transaction as efficiently as possible.

“If the seller is well prepared, the due diligence process can enhance the seller’s credibility with the buyer,” Faust says. “On the other hand, if the seller’s due diligence responses are slow or incomplete, the buyer may start doubting whether it wants to complete the transaction, or at least at the original purchase price.”

The due diligence process can feel overwhelming, but it comes down to a couple of simple questions, says Faust. Ask yourself:

1. What are people going to ask me about?
2. What would I want to know if I were buying this business?

“Generally speaking, buyers are going to want pertinent information about your employees, your customers, your litigation history, your material contracts, your business assets, etc. It would serve sellers well if, in the ordinary course of business, prior to any potential sale activity, they developed a system of maintaining those records. Then, if an M&A transaction does happen, you’re already prepared. And even if an M&A deal doesn’t happen, it’s good to have that information readily available anyway,” Faust says.

An M&A Due Diligence Checklist

An M&A due diligence checklist can help you anticipate document requests. Though not an exhaustive list, here are some key things you’ll want to be ready for in due diligence:

1. Financial Performance

Acquirers in an M&A transaction want to obtain financial statements to learn about the company’s cash flow and expenditures, largest customers and existing sales agreements, company products and backlogs, balance sheets, and budgets.

2. Tax Information

Parties to an M&A transaction should share tax information from the last several years, including federal and state tax returns, information regarding any IRS audits, and tax liabilities.

3. Business and Corporate Information

“Check your corporate records, which is something that comes up frequently and often more than other aspects of due diligence,” says Faust. “Many small and midsize companies often don’t do a great job of maintaining their corporate records, in terms of their corporate authorizations, resolutions, etc.” For example, an acquirer wants to understand your company’s organizational charts, subsidiaries, articles of incorporation, bylaws, and amendments.

4. Employee and Human Resources Information

Include information about employment agreements, including NDAs, non-competes, and exclusivity agreements. Provide employment agreements, employee handbooks, details on employee benefits, workers’ compensation, retirement, and any stock options.

5. Intellectual Property (IP)

What are your company’s intellectual property rights? What are your IP protections? Important forms of IP include patents, trademarks, trade secrets, and copyright.

6. Real Estate

What real property does your business own? Are there any liens or leases that the acquiring company should be aware of? Provide deeds, mortgage documents, and other documentation relating to property.

7. Environmental Liabilities

In some mergers & acquisitions, environmental review and compliance with Environmental Protection Agency (EPA) regulations on matters such as hazardous substances and cleanup are essential.

8. Regulatory Compliance

A merger or acquisition can give your company a competitive advantage. However, you want to make sure it doesn’t run afoul of any antitrust or competition issues. Getting a legal review of antitrust laws and other federal or state regulatory requirements is essential.

9. Legal Information

Are there any concerning legal liabilities or risks? Is there any existing or anticipated litigation against the company? Was there litigation in the past, and how was it settled? Are there any litigation settlement documents?

Do I Need a Lawyer on My M&A Due Diligence Team?

The answer is a definite yes.

“Due diligence is a collective effort,” Faust says. “It’s a divide-and-conquer approach by your deal team. Lawyers are an integral part of that team. Lawyers are trained to spot legal issues and typically take the lead on legal matters. Other members of the team are more likely to review financial matters.”

How Can I Make the M&A Due Diligence Process Efficient?

There are a few things both sides in an M&A transaction can do to make the process as efficient as possible.

“One of the first things a buyer should do is assemble the buyer’s deal team. That team includes lawyers, accountants, investment bankers, key employees, and others,” says Faust. “There’s some overlap in what some of these team members can do. In light of that, it’s important they work well together so there’s no duplication, but also so that nothing falls through the cracks.”

Keep Lines of Communication Open During Due Diligence

Good communication is essential to the integration process so everyone knows “who’s doing what, and there are no turf wars,” says Faust.

“There should be frequent and regular meetings or other communications with team members after setting things up. This ensures that information is quickly provided and questions answered to facilitate a smooth transaction.”

Consider Using a Data Room for Due Diligence

Another thing that can be extremely helpful in the due diligence process is a data room. A data room is a virtual repository for all the documents you need in the due diligence process.

“One of the most common complaints from sellers is that they’ve been asked to provide the same information to three or four different people — for example, buyers, lawyers, investment bankers, lenders, mezzanine lenders, etc.,” says Faust. “A data room alleviates that frustration. You provide the information and documents once, and as long as the other parties have access to the data room, they can get that information and any document as they need it.”

Data rooms can also be set up to track the due diligence request list. “So, data room folders track the requests, and it’s easier for people to find the information they’re looking for and avoid struggling to find the information and documents they are seeking.”

For sellers running a business at the same time that they’re trying to sell their business, it can be “very hectic and frustrating,” says Faust. “Having a data room can help release some of that stress.”

Note: Data Room Users Still Must Give Information in Purchase Agreement Schedules

However, if you use a data room, there’s a common misunderstanding to avoid. “Sellers sometimes assume that because all the information has already been uploaded in the data room or otherwise provided to a buyer, it’s taken care of. But even though it’s uploaded to the data room, you must still include it in the disclosure schedules to the purchase agreement,” says Faust.

“The schedules are either exceptions to representations and warranties in the purchase agreement about the business or items specifically asked for in the reps and warranties. I like to remind the sellers to assume that whoever is reading the purchase agreement and disclosure schedules has never talked to the sellers about the deal before and has never visited the data room.”

Get an M&A Attorney

An M&A lawyer can ensure a smooth transition and avoid the potential risks of your merger or acquisition. Find an experienced mergers and acquisitions attorney in the Super Lawyers directory.