Five Focus Points while conducting legal due diligence before any transaction:
- Non – Disclosure Agreement
The due diligence exercise commences with sharing of vital information and documents of the target business with the prospective investor / buyer / acquirer. It is common for such documents to include confidential and proprietary information. Since a due diligence exercise generally precedes the decision to enter or withdraw from the deal, the likelihood of leaking of secrets cannot be completely ruled out in case the transaction is not successfully closed. Therefore, it is must for the business owners to have a comprehensive NDA executed with the prospective investor before sharing the information in order to preclude them and their agents from disclosing the information.
- Approvals, Licenses & Compliance
Cross checking of the regulatory approvals and licenses is a significant part of legal due diligence. This would not only involve the validity check of the approvals / licenses but the lawyers are also expected to analyze whether or not the business operations are in conformity with the terms of such approvals and licenses. In certain cases, some specific approvals and licenses are also instrumental in deciding the fate of the deal. Therefore, these checks are extensively conducted in order to identify such ‘deal breakers’ and ‘deal changers’. The parties also rely on the outcome of these checks to ascertain the risks that may follow after the deal and to safeguard themselves from such risks and liabilities. It is therefore necessary for the business owners to obtain appropriate licenses and comply with all applicable laws so as to not lose the bargaining edge because of the legal complexities.
- Material Contracts
Contracts are an integral part of any business organisation. During a legal due diligence, they assist in identifying different stakeholders of the business and also helps to determine the scope and extent of their rights / obligations vis-a-vis the promoters and the company. It is must to thoroughly scrutinize all material contracts like co-founders’ agreement, shareholders agreement, lease and license, IP transfer agreements, vendor contracts, service level agreements etc. The detailed inspection of the clauses of these contracts backed by a thorough legal research helps in detecting the restrictions which may prove to be fatal for the transactions. Such restrictive clauses vary from contract to contract for example limitation of liabilities, restriction on transfer of shares, term, exclusive or non-exclusive, non-compete, jurisdiction etc.
- Litigation History
Pending litigation or unfavourable decrees bring a considerable amount of uncertainty for any prospective investor / buyer / acquirer to even make a deserving offer. The business owners should ensure that they are not extensively involved in litigation and disputes. On the other hand, for the other party, it is immensely important to closely examine the documents of such disputes and court proceedings in order to determine the extent of risks involved and liabilities which may be imposed post transaction. Non-compliance of applicable laws in certain cases may also attract heavy penalties. In this regard, regulatory and / or quasi judicial proceedings must also be closely monitored while conducting a legal due diligence.
- Status of Assets & IP
Value and ownership of the assets are two predominant considerations for negotiating the numbers in any transaction. Proper inspection of the documents to check the chain of ownership and validity of title is indispensable while conducting legal due diligence. The aim is to foresee potential risks, liabilities, charges, encumbrances and other restrictions that may be attached to such assets. In today’s evolving and tech based business environment, the ownership status of the Intellectual Property is also crucial for the prospective investor. Therefore, ownership over the Intellectual Property and the confidentiality with respect to the knowhow of the business must also be reviewed during the legal due diligence.
Ayush Beotra is an Associate Partner at Innovatus Law, a New Delhi based multi-disciplinary law firm specializing in dispute resolution and general corporate practice. Ayush regularly advises businesses on various legal issues of general corporate commercial law. Ayush can be reached at firstname.lastname@example.org.Disclaimer: The views or opinions expressed are solely of the author.