Legal Due Diligence — M&A lawyers’ 5 top tips when buying a business

Legal Due Diligence (LDD) can be a real pain point for both buyers and sellers of businesses. If it’s not approached properly, it can prove to be lengthy, attritional and expensive and ultimately add limited value to the specific deal terms and documentation. 

Here, expert corporate transaction lawyers Jon Close and Rupert Gill share their top tips for anyone buying a business to help you get the most out of the LDD process.

1. Take a tailored approach 

To ensure that the deal process starts on the right footing, it’s always advisable to ask your lawyers to produce a tailored LDD questionnaire for the target business.

Asking irrelevant questions at the start of the process — for example, in relation to stock or work-in-progress when the target doesn’t carry any — will only aggravate the sellers. So, ensure that your lawyers understand the target business and are asking the right questions at the outset. 

This principle applies to any further enquiries that may be raised as you move through the process — they also need to be relevant, specific and structured in a way that enables them to be answered meaningfully.

2. Don’t jump the gun 

If the deal timetable allows, you should only instruct your lawyers to commence their LDD once the sellers’ virtual data room (VDR) has been substantially (more than 80%) populated, is properly organised (and indexed) and includes a full set of responses to the LDD questionnaire. 

Always make the sellers (and their lawyers) aware of this requirement so that they prioritise the LDD exercise and ensure that once opened, the VDR is due diligence ready. If it’s not ready, don’t be afraid to push back to the sellers and make it clear that your lawyers won’t be going into the VDR until it’s ready.  

This approach should help to make the process more efficient — both in terms of your time and legal costs — as your lawyers shouldn’t have to keep dipping in and out of the VDR. It’ll also be less attritional and more transparent so that both parties know what’s required of them to move the process along. This should avoid either party playing the ‘blame game’ later in the process when the transaction may be delayed because of the time taken to complete the LDD. 

If, on the other hand, the deal timetable is tight and doesn’t allow for the above approach, you should make it clear to the sellers and their lawyers which LDD areas they need to prioritise first. 

The key to a smooth LDD process is setting your expectations and clearly communicating with the sellers at the outset of the deal. A comprehensive deal timetable should help to get the sellers’ buy-in to the above approach.

3. Agree a clear scope 

Once the VDR has been substantially populated, it’s always a good idea for a buyer and their lawyers to take the time to agree who’s going to review what (and in what level of detail). We find that certain buy-side clients prefer to carry out some due diligence in-house — especially in relation to HR, insurance or customer contracts — as they have a closer understanding of those particular areas of the target business. This also helps to keep the LDD costs down.  

Agreeing a clearly defined scope of work with your lawyers at the outset will allow them to understand:

• Which areas of the target business are of material importance to you as the buyer.
• Which areas you require them to report on and in what level of detail.
• What level of materiality they should apply in assessing any LDD risks in the target business — whether that be a financial threshold or some other objective threshold. 

If your lawyers are unsure on any of the above, they should ask for your guidance at the outset rather than making assumptions. Ultimately, you won’t appreciate their additional time costs on reporting on issues which aren’t relevant or important to you as the buyer.   

A good LDD exercise should always be dynamic and collaborative, with a buyer and their lawyers continually checking in with each other and the lawyers only reporting on what they need to. With this in mind, it’s a good idea to schedule regular LDD check-ins as you go through the process.

4. Agree form of LDD report

LDD reports can vary enormously in terms of their length, reporting style and level of user friendliness. There’s no ‘one size fits all’ solution and LDD should always be tailored to meet a client’s specific needs. 

As a client, it’s important to be clear with your lawyers on what you’re expecting — whether that be a detailed report, short overview or ‘red flag’ (material issues only) style — as the format will ultimately have time and cost consequences for you as the client.

If the transaction is to be insurance-backed through a warranty and indemnity insurance policy, you should always be mindful of the insurer’s requirements so that you can frame your LDD accordingly. A quality LDD report should attract less questions from the insurance provider and help to speed up the underwriting process.

Poor management of LDD can lead to scope creep and cost overruns which can come as nasty surprises to clients at the end of the deal process. To mitigate these risks, from the point of instruction you should make it clear to your lawyers that you’d like to be kept fully informed of any scope changes or resultant cost increases in advance of any extra work being undertaken. 

From a practical perspective — and to further streamline the process — ask your lawyers to limit the reporting process to two drafts of the LDD report to ensure that you won’t have to spend excessive time reviewing multiple drafts of the same report. This will also help to avoid any cost overruns. 

5. Summary of key issues & recommendations 

The real value of a good LDD report lies in its executive summary and the clear signposting by your lawyers of any material risks or liabilities in the target business, along with their recommendations to rectify or mitigate those risks. 

Such recommendations may include the need for the sellers to take certain pre-emptive actions prior to completion, which could be:

• Obtaining change of control consents from the target’s key customers.
• Implementing new contracts for key employees.
• Additional warranties and/or indemnities in the sale and purchase agreement to address any specific information gaps or risks arising from the LDD process.
• Specific adjustments to the locked box or completion accounts for any debt-like items such as early repayment charges or property dilapidations. 

Ultimately, any legal issues that could potentially impact the price being offered for the target business need to be clearly identified and advised on.   

A good LDD report should also summarise any post-completion actions required or recommendations to help integrate the target business within the buyer’s group and eliminate or mitigate some of the material legal risks identified in the report.     

While detailed summaries of key customer/supplier contracts, property leases or employment contracts are useful sources of information, they’re best placed as schedules at the back of the report. The front end should be reserved for the key issues, recommendations and actions outlined above. This should enable you to get to grips with any issues quickly without having to read through reams of information.  

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It’s surprising how quickly a due diligence process can go awry without a clear scope of work in place and clear lines of communication with your lawyers. 

Agreeing expectations upfront should ensure that the LDD report covers what you need it to, adds real value and is delivered within budget. In our experience, following these tips should help you to achieve these key outputs and avoid any unpleasant surprises on fees at completion.

If you have any questions or would like a no-obligation conversation with one of our legal due diligence specialists, talk to us by giving us a call, sending us an email or completing our contact form below.