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

Ensure your business knows what it’s acquiring

By Canaan Suitt, J.D. | Last updated on April 17, 2023 Featuring practical insights from contributing attorney Pete Faust

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Due diligence is an essential step in any big purchase. It’s basically verifying the facts about what you’re seeking to acquire.

Say you’re looking to buy a used car, for example. You have a pretty good idea of the style and price range you want. After some initial research, you find a used car that seems to meet your criteria.

At this point, what do you do? Since it’s a significant purchase, you probably want to take the car for a test drive or have a trusted mechanic look it over before finalizing anything. Does it really have the features you want? What’s the actual mileage? Are you going to have to do a bunch of repairs? This is due diligence.

Due diligence is even more critical when it’s your business that is looking to merge with or acquire a target company.

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

Because companies are complex entities, M&A due diligence can be pretty complicated. It’s not a process that a business owner can do alone. Instead, you will have an M&A transaction team to 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 Should I Start Preparing to Sell My Business?

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

One of the many benefits of planning ahead is that it helps keep things under wraps until you’re ready to make things 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 to be prepared 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,” says Faust. “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 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 after the parties to an M&A deal have signed the letter of intent (LOI). The LOI describes the essentials of the deal, including what is being acquired and for how much, who is buying, and the transaction timeframe. While nonbinding, the LOI is an important milestone in the M&A process.

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

Pete Faust

Preparing for Due Diligence: Seller’s Standpoint

From the seller’s standpoint, the goal is to ensure that all key information about the business is readily available so the M&A transaction can be conducted 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 to a couple of simple questions, says Faust. Ask yourself: What are people going to ask me about? 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.,” explains Faust.

“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,” he adds.

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 prepared for in due diligence:

  • Financial Information. 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 sale agreements, company products and backlogs, balance sheets, and budgets.
  • 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.
  • 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, and bylaws and amendments.
  • Employee and human resources information. Include information about employment agreements, including nondisclosure, non-compete, and exclusivity agreements. Provide the employee handbook, including details on employee benefits, workers’ compensation, and retirement and stock options.
  • Intellectual property (IP). What are your company’s IP rights? How is your IP legally protected? Important forms of IP include patents, trademarks, trade secrets, and copyright.
  • 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.
  • Environmental Liabilities. In some mergers & acquisitions, environmental review and compliance with Environmental Protection Agency (EPA) regulations on matters such as hazardous substances and cleanup is essential.
  • Regulatory Compliance. A merger or acquisition can give your company a competitive advantage, but you want to make sure it doesn’t run afoul of any antitrust or competition issues. Getting a legal review of antitrust and other federal or state regulatory issues is essential.
  • Legal Information. Does the company have any legal liabilities or risks to be concerned about? 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 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 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.

Take a Team Approach

“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 the Lines of Communication Open

Good communication is essential 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. Then, going forward, ensure that information is quickly provided and questions answered to facilitate a smooth transaction.”

Consider Using a Data Room

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 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 already been taken care of. But even though it’s uploaded to the data room, it still must also be included 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 that are specifically asked to be listed 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

To get a highly experienced lawyer in your jurisdiction, look for a mergers & acquisitions attorney in the Super Lawyers directory.

For more information about this legal area, read our mergers & acquisitions law overview.

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