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Legal Due Diligence and M&A

Vaishnavi Reddy

February 28, 2021

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The realm of corporate law holds a versatile set of opportunities in every business field and comes with industry-related challenges that can be navigated successfully only if the legal teams are well acquainted with the ever-changing market-specific business laws and developments in legislative and regulatory mandates. The recent increase in the number of corporate law players has given corporate houses the option to choose the firm that offers maximum flexibility, affordability, and supreme quality of service. One of the biggest hurdles that law firms face is the communication gap between the lawyer and the clients. Many lawyers find it quite challenging to make their clients understand all the legal verbiage in their collaborations, billings, agreements, and other reports and perform multiple iterations to convert the legal information into usable forms of business intelligence.

Legal due diligence is one practice that is executed multiple times during a company life cycle. It is an integral part of legal tasks that any firm performs whenever there is an M&A or a potential investment or licensing. It is primarily an investigation and analysis of the company’s obligations, liabilities, and perceived value. It involves an intensive audit of all the assets the seller owns that might include infrastructure, machinery, inventory, cash and securities, intellectual property, accounts receivable and also the liabilities such as accruals, product warranties, lease payments, employee benefits, debts, trade payables and tax liabilities that helps understand the worth of the business before drafting negotiations on the buyer and seller side independently. This practice gives the buyer a clear picture of the relationship between the company and its stakeholders and the risk of litigation. The lawyers often have to operate with limited time and budget producing thorough reports which do not cause any problems during the transaction and later.

They check if the seller is compliant with all the laws and regulations that it is subjected to, if there are any contractual agreements or changes in ownership that crystallize liabilities post-acquisition, if the seller is exposed to some risks that the buyer isn’t aware of due to a difference in products/services, seasonality, geographical position, etc. and if the seller has settled all of its debts on time. The legal team also studies all of its constitutional documents such as Memorandum of Association, Charter, and Shareholders agreements to ensure that no surprise entities surface post-acquisition and reveal how the board of directors of a company is appointed and function. Contracts are another significant part of legal due diligence. It is necessary to review all the customer, supplier, operational contracts and licenses that the company holds to determine the relevant parties, change of control provisions, renewal and termination procedures, contract-based ownerships, pricing mechanisms and any verbal contracts between the seller and a third party that the buyer must take into consideration. Additionally, they are required to review the company’s insurance coverage to make sure it is standardized and understand its business profile, fundamental operations, claims history, compliance with terms and conditions of each of the policies and also predict any shortcomings to the present coverage and estimate the cost to obtain ample cover.

Despite such stringent practices, there is always room for some unavoidable bias amongst the employees, researchers, and owners, which may hinder the outcome of the legal due diligence. With such glitches, the companies are looking for an extra layer of protection called ‘representation and warranties liability insurance’ when they go through M&A or any investment activities that enable them to shield them from misinformation, errors, and misstatements. Escrows and earn-outs are designed to provide flexibility and recourse to the acquirer and help manage the future performance and its ability to meet set objectives under the acquirer in the event of breaches and misrepresentations on the seller’s end.

On the broader horizon, the duties of legal teams go beyond due diligence in M&A transactions. They are responsible for drafting all the agreements that enable the smooth merger or stock purchase or asset sale. They construct legal boundaries for liability transferability, third party contractual consent, stockholder approval, and tax consequences. They also play a central role in curbing conflicts arising due to cash vs. equity issues and working capital adjustments and produce iron-clad agreements benefitting both parties. The disclosure schedules are designed by the legal team too that necessarily require the seller to state that no warranty or representation contains any errors or exceptional information that confuses the buyer due to many knowledge qualifiers that the seller adds to protect itself from any risk and litigation. Closing conditions require high approval voting from the seller’s stockholders i.e., about 90% and a certified legal opinion of both parties’ counsel and hence demands the lawyers to review the stakeholder structure to ensure that there are no last-minute surprises on both ends. Post-M&A. Furthermore, it is highly imperative for an acquirer to create non-competes and solicits that guarantee that the seller doesn’t engage in a business activity that is competitive to the acquired business and poach the customers, partners, and employees of the same for an agreed-upon time and scope.

It has become increasingly evident that these processes are highly language-sensitive, and the slightest miscommunication or misunderstanding can have afflictive consequences. Most of the above procedures involve staff from diverse disciplines working on different templates of data. It calls for extensive standardization of information of both the parties and the internal legal and other departments to cut down conflicts, staff-hours, and redundancy. Subtl can play a vital role in integrating external and internal data that can avoid linguistic confusion amongst clients, lawyers, and opposing parties and intelligently understand and retrieve the necessary information instantly. It helps lawyers cross-reference their data with previous M&As and assess the value and KPIs of the operations without any existential bias. Subtl can enable exposing and modifying contractual exceptions, underlying liabilities, tax consequences, compliance, and other red flags with much higher accuracy, accountability, and with smaller legal teams that can accomplish smooth and mutually beneficial M& As and investments with almost zero conflicts.

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Vaishnavi Reddy

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