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Due Diligence – the key to a successful M&A
Changing market conditions, expansion due to business development, or on the contrary, the intention to close the business. There are number of reasons why entrepreneurs decide to make a transaction of, accordingly, acquiring a new entity, or selling a currently conducted company.
A large number of factors that should be remembered in such a situation, cause that even the most experienced investor can have problems with an adequate assessment of the condition of the company. For this purpose, except from listening to the often-deciding voice of intuition, the best solution is to refer to the objective criteria, related to the financial parameters and the legal state of the company itself.
If you want to rest assured that the business valuation will be conducted with attention to every detail, decide to carry out the audit expertly called due diligence research.
The evaluation can take a number of forms, dependent on a role of the entity in the planned transaction, as well as the range of the factors checked. Depending on the entrepreneurs’ needs, the solutions offered on the market are mainly financial and tax services, or legal due diligence.
The role of legal audits in strengthening confidence in transactions
Acquisitions or sales of a company (enterprise) are commonly referred to as M&A transactions (Mergers and Acquisitions).
To make sure that the M&A transaction is undertaken safely, prospective acquirers have to become familiar with the condition of the acquired company (so-called target). Getting such data is getting information about the potential risks concerning the functioning of the taken entity, especially the legality of conducted activity and possible legal restrictions regarding execution of the potential transaction.
On the other hand, an adequate legal revision of a disposed company is an operation wanted from the perspective of a prospective seller, who thanks to the information obtained in this way, can properly prepare for the planned transaction. An entrepreneur will have a chance for an eventual correction of errors, preceding the process of selling, as well as will have the possibility to properly determine the value of the entity and prepare the right negotiating strategy, which considers the condition of the conducted company.
By the way, it should be noted that the planned transaction doesn’t always imply full disposal of a target. It often happens that its owners aiming at looking for the new sources of funding, pay attention to the investor, who is an external entity interested in acquiring only a part of the enterprise (or entering to collectively run a business). There is no doubt, that this type of transaction also requires the potential sides to become familiar with the condition of the acquired company.
Due diligence research is used to meet the solid familiarization with the condition of the economic entity which is the subject of the planned transaction. Due to the possibility (often the necessity) to carry out the research on various levels of types of a target’s business activity, as mentioned above financial and tax services, or legal due diligence should be brought up.
Due diligence goes beyond legal issues alone
What is due diligence?
Speaking as simply as possible, due diligence in M&A transactions should be understood as a process of studying a given entity in the context of the planned transaction. Therefore, in case of legal due diligence we are talking about an analysis of the given entity with regard to the legality of its activity.
Due to the entity ordering to conduct due diligence, there should be distinguished:
- the research conducted on a potential vendor’s request (vendor due diligence – VDD)
- the research conducted on a potential buyer’s request (buyer due diligence – BDD).
The scope of legal due diligence
Unfortunately, it’s not easy to clearly determine the scope of the research necessary to efficiently undertake the transaction.
Properly conducted due diligence should have an individualized character, dependent on the character of the conducted business activity. Additionally, the preferences of the parties interested in a potential transaction are also very important, since any party may be interested in conducting due diligence only in a defined scope (or in more detailed evaluation of selected topics).
Corporate Advisory RSM Poland Team provides comprehensive services in the field of legal due diligence, dedicated not only to potential vendors, but also to business purchasers, covering a legal audit in the range settled with the client.
However, given the fact that the target is most commonly the entity who runs a business as a commercial company, especially in a form of a limited company (i.e., a company with limited liability, simple joint-stock company or joint-stock company) one of the core issues studied during legal due diligence by RSM Poland are so-called corporate affairs, concerning the compliance of the functioning of the company with the provisions of the Commercial Companies Code.
The research is conducted with regard to verifying:
- proper representation of a company in rights management or incurring liabilities, also proper keeping of internal documentation,
- proper contribution of partners (shareholders) and proper registration in the National Court Register all the changes concerning the target (company), including the changes in ownership structure and in company’s bodies.
These matters are fundamental for organizing the target’s activity; therefore, they are the starting point for further assessment of the correctness of its functioning.
Moreover, the most frequent topics of due diligence conducted by RSM Poland are:
- property law, with particular emphasis on analysis of the legal status of the property belonging to the company,
- labour law,
- trade agreements (including the agreements with related parties),
- intellectual property rights,
- administrative law (with particular emphasis on granted authorisations, licences and concessions),
- legal and enforcement proceedings carried out with the participation of the target (in the context of their impact on the functioning of the sold entity),
though, this list contains only the most important matters concerning the operation on the market. An entrepreneur should always remember that an effective assessment of the scope of the research each time should include the individual condition of the given entity.
Proper specifying the scope of due diligence may be very important for the transaction. On the one hand, too superficial research raises the risk of a lack of adequate familiarization with the target’s functioning, therefore it can lead to acquirer’s distrust (such a situation can often make the vendor provide additional assurances or can cause the necessity to add a significant number of objections concerning the payment of all or the part of the agreed sale price). On the other hand, specifying the scope of due diligence in a too detailed way may be excessively problematic, and consequently complicate the whole process, and can even discourage the parties from making a deal.
Why is it worth deciding on a legal audit with RSM Poland?
Proper conducting due diligence requires not only extensive knowledge, but also experience and adequate planning of the whole process. Deciding to entrust due diligence to RSM Poland, you choose:
- cooperation with the team of specialists who have extensive experience in providing comprehensive services to business entities, constantly improving their qualifications and following the changing market trends;
- our experts’ full commitment to a project;
- service fully adjusted to your individual needs and cooperation based on mutual understanding and trust;
- modern way of communication, providing the smooth and convenient exchange of information;
- possibility to cooperate with the other departments of RSM Poland to simultaneously conduct financial and tax due diligence, and if necessary, the services concerning a search for investors, as well as the assistance at the execution stage of the transaction;
- possibility to cooperate with the entity affiliated in the RSM group, one of the top advisory groups in the World.
The course of due diligence
Bearing in mind that due diligence serves to research the specific entity, RSM Poland team during this process relies on analysing the data on the functioning of the enterprise. Usually, regardless of the type of due diligence (VDD or BDD), the data comes from the documents and the explanations provided by the target.
Firstly, each time we prepare the list of the documents and the explanations essential for conducting the research. Then, after receiving it, the team carrying due diligence start to diligently analyse them. At this stage, depending on the agreements made by the parties, additional questions and the requests to present further documentation may arise. Moreover, received documents and the explanations are verified with the information in publicly available registers (such as the National Court Register, land registers, trademark and industrial design registers conducted by The Polish Patent Office and The European Union Intellectual Property Office – EUIPO).
Often, it is helpful to get acquainted with the register files about the company that is the subject of the potential transaction. This type of action is undertaken by the RSM Poland team especially in the case of difficulties in obtaining the specific information directly from the entity examined.
There, it should be indicated, that in the era of computerization, to ensure the effective exchange of information, a practical solution is to create a VDR platform (Virtual Data Room), thanks to which the representatives of the disposed entity provide the RSM Poland team conducting due diligence with access to all the required documents and information.
The final effect of the analysis conducted, is a proper report, of which the scope and the editing depend on the agreements made with the client. In practice, the most frequent solution used by RSM Poland is to prepare a comprehensive report covering the practical and transparent recognition of the research results, containing both descriptive elements and pointed distinction of the most important topics.
This form of providing information is most frequently recommended due to practical reasons, depending on the circumstances or client’s individual preferences, we are ready to prepare a report of only descriptive character or a report of only point character in which we will only point the most important risks identified during the research (so-called red flag report).
Our offer of legal due diligence
Bearing in mind the aim of conducting legal due diligence, we are ready to prepare an offer adjusted to your individual needs, in the case of both, the planned disposal (VDD) or acquiring (BDD) the target.
The scope of the research and the type of the report (also the way of calculating the remuneration for the services provided) each time is discussed with the client. Our goal is to recognize your expectations and, if necessary, suggest the optimal solutions with regard to the planned transaction, which will allow the effective conducting of the whole process.
We provide services in the Polish language, as well as in the English language.
Frequently asked questions: What should I know about legal due diligence?
To put this issue as simply as possible, due diligence is the process of examining a specific entity (or company or assets) with regard to a planned transaction. In the case of legal due diligence, we are talking about examining a given entity in terms of the compliance of its operations with applicable law.
Legal due diligence is generally ordered by the parties to the transaction. For this reason, there is a division into buyer's due diligence and vendor's due diligence. In practice, transactions are often preceded by both types of analyses - i.e. analysis carried out first by the vendor and then by the buyer.
Vendor Due Diligence, being a review commissioned by the sell side, allows legal issues and transaction risks to be identified and, where appropriate, addressed before the sale process formally begins. At an early stage, the findings may influence the seller's decision regarding whether to proceed with the transaction in question and help determine its key commercial parameters. During the sale process itself, Vendor Due Diligence may accelerate negotiations, prepare the seller for the purchaser's Due Diligence process and increase the overall predictability of the transaction.
The scope of a legal audit (legal due diligence) depends on the type of transaction and the individual preferences of the client. The subject of the transaction itself plays an important role here - the scope of the examination is different in the case of the acquisition (sale) of a company, enterprise or only specific assets (e.g. real estate or intellectual property rights) - and the conditions relating to a specific industry. Therefore, determining the scope of a legal audit should be individualized each time, taking into account all the above-mentioned factors.
The scope of a Legal Due Diligence review should be tailored to the target company's business profile and proportionate to:
- the nature of the transaction,
- the size of the target,
- the level of risk involved,
- the client’s expectations.
The assessment of a technology start-up will differ significantly from the review of a manufacturing business holding real estate assets, operating licences and relying on a complex workforce structure. As a matter of best practice, a risk-based approach should be adopted, focusing on areas that may have the most significant impact on the considered investment.
This issue depends on the specific scope of the audit, but generally speaking, in the case of an audit carried out by a potential vendor, the aim is to verify the occurrence of potential irregularities that may lead to a reduction in the sales price, while in the case of an audit carried out by a potential buyer, the aim is to determine the risks associated with the acquisition of the subject of the transaction.
Material agreements frequently contain change of control provisions, assignment restrictions, exclusivity arrangements or contractual penalty clauses that may materially affect the considered transaction. In certain cases, particularly in relation to financing agreements, a change in company ownership may itself trigger additional obligations or entitle the counterparty to terminate the agreement. Other commercial aspects are also relevant, including the contract duration (as short-term contracts expose the purchaser to the risk of losing a key customer or supplier).
In technology companies, e-commerce businesses and service providers, intellectual property rights often constitute a key value driver and may be essential to the target's day-to-day operations or form a core component of the investment rationale from the purchaser's perspective.
An intellectual property review enables the investor to verify, among other things, whether the target company validly owns the necessary rights to use its trademarks, software, databases or proprietary know-how.
Nowadays, more often than not, Legal Due Diligence reviews encompass an assessment of compliance with environmental, labour, business ethics and corporate governance requirements. Furthermore, it should be noted that certain categories of entities are currently subject to mandatory ESG reporting and periodic assurance or audit requirements. Any related non-compliance may result in regulatory sanctions, reputational damage and restricted access to financing.
Absolutely. The findings of a Legal Due Diligence review may affect not only the purchase price but also the choice of its structure and, in extreme cases, may lead to a decision not to proceed with the investment. Depending on the risks identified, an investor may decide to:
- acquire selected assets instead of shares,
- implement a phased acquisition strategy,
- introduce additional contractual safeguards, whether through the share purchase agreement itself or by entering into supplementary agreements or arrangements with the existing shareholders).
Such mechanisms help mitigate exposure to identified legal pitfalls and provide greater control over the investment risk profile.
The summary of legal due diligence is made in the form of a report, which may take the form of a red-flag report or a descriptive report.
The due diligence report is a document summarizing the legal analysis conducted. The type and method of its editing depend on the scope of the study agreed with the client and the client's individual preferences. Among the possible forms of reports, there are in particular a red-flag report, detailing only the most serious risks related to a potential transaction, and a descriptive report, indicating detailed information about the subject of the transaction (the so-called target).
A Red Flag Report focuses exclusively on key risks that may affect an investor's decision-making process or the commercial terms of the transaction in question.
A Full Legal Due Diligence Report, on the other hand, provides an all-encompassing analysis of the target company across all reviewed areas. It typically includes a detailed assessment of the target's legal status, identifies potential legal risks for the investor and sets out recommendations regarding the further course of action.
The greatest benefit of conducting legal due diligence is obtaining detailed information about the subject of the transaction. The information obtained in this way is extremely important for both parties to a potential contract at the stage of negotiating the terms of a specific transaction - especially when setting the appropriate price.
A Virtual Data Room (VDR) is a secure electronic platform used for the exchange of documents and information between the transaction parties and their advisors conducting the Due Diligence process.
This solution enables efficient and secure sharing of documentation without the need for daunting exchanges of hard-copy originals. A VDR also facilitates transparent document version control, access management, Q&A communication workflows and user activity monitoring.
Risks identified during the Legal Due Diligence process are frequently reflected in the provisions of the transaction documentation, including share purchase agreements, business transfer agreements or asset purchase agreements. They may result in additional representations and warranties, indemnities, conditions precedent and purchase price adjustments. In severe cases, where material risks are identified, the findings may ultimately lead to the abandonment of the transaction or a restructuring of the proposed deal.
The findings of a Legal Due Diligence review help identify areas requiring remediation or alignment with the acquirer's organisational framework following completion of the transaction. This may include:
- updating contractual agreements,
- regularising corporate documentation,
- changes to compliance policies,
- adapting data protection processes and IT systems.
Common recommendations include:
- regularising corporate records,
- updating commercial agreements,
- addressing issues relating to intellectual property and industrial property rights,
- implementing or integrating compliance procedures,
- aligning data protection practices with GDPR requirements,
- mitigating risks arising from ongoing disputes or contractual liabilities,
- integrating the IT environment.
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