In this post I will explain the goals of legal due diligence ("DD") reports, information request lists ("IRL") and the importance of legal DD in M&A transactions. Let's start:
A - Goals of Legal DD
Almost every M&A transaction involves a DD process, regardless of the jurisdiction in which the transaction would take place. This process usually involves inputs from multiple teams, such as financial, tax, legal and technical DD teams.
The legal DD may be carried out by the vendor prior to negotiating with potential buyer(s). In that case the report prepared at the end of the exercise would be referred to as a "vendor's DD report". The DD may also be carried out by potential buyers following the execution of a non-disclosure agreement (NDA). In that case the end-product would be referred to as "buy-side DD report".
The goals of legal DD reports - that are specific to vendor's reports - can be summarized as follows:
On the other hand legal DD reports - that are specific to buy-side reports - can be summarized as follows:
B - Information Request Lists (IRL)
In order for the buy-side parties and their legal teams to conduct DD on target companies, they would need access to target companies' information. These information are often listed under a document called an IRL. The list is usually sent to the vendor's legal team.
Depending on the industry of the target company or the nature of the transaction, the content of the IRLs can vary. However most IRLs include the following sections:
Depending on the industry of the target company, the IRL can also include:
C - Components of Legal DD Reports
As a response to the IRLs, the legal DD teams are provided with the required documents and a legal DD report is prepared at the end.
Whether it is a vendor's report or a buy-side report, the reports usually have the following findings in it:
D - Importance of Legal DD Reports
Conclusion of legal DD reports can be "make or break" moments for a transaction. In the case of vendor's DD report, the vendor can actually abort the idea of selling the target company altogether. This can happen if the DD reports points out that there are too many "housekeeping items" that it is not feasible for the vendor company to complete them in the short-term; or the DD report can point out that the valuation of company should actually be much higher than the vendor's expectation.
The legal DD report is equally - if not more - crucial for the buy-side. It is absolutely common for buy-side parties to walk away from a transaction because of the findings of a legal DD report. It is also very common for the parties to negotiate a completely different price tag for the target company due to such findings.
If the buy-side's DD report fails to detect crucial issues pertaining to the target company, the buyer can face with a disastrous situation and never be able to financially recover from the investment in that particular target company.
E - Conclusion
To summarize the above, the goals of legal DD are various and essential to both buyers and sellers. IRL is the main document which lists the legal team's document requests. The components of the report are aligned with the IRL. Lastly the legal DD reports are indispensable for deciding whether a particular transaction would be consummated or not.