What is important in a due diligence review? How do we approach the process? In this article, we will examine these questions in detail. We will explain what due diligence means exactly, why it is so essential and what special tasks a lawyer takes on in order to protect your interests as best as possible.
What is Due Diligence?
Due diligence refers to the careful examination and analysis of a company or asset before a transaction such as a purchase, merger or other investment, for example in the form of an investment. Originally from finance, the term has now been expanded to include many areas. As part of a due diligence, all relevant information is collected and analyzed for existing risks.
Why is due diligence important?
Due diligence helps to identify risks and make informed decisions. Without a thorough examination, hidden problems and financial risks can be overlooked, which can lead to significant losses. It is therefore an indispensable part of any large transaction. Conducting due diligence gives potential buyers a comprehensive overview of the opportunities and risks of an investment and consequently helps them to take these opportunities and risks into account in price negotiations.
Role of a Due Diligence Lawyer
A due diligence lawyer acting on behalf of the buyer is specially trained to thoroughly examine all legal aspects of a company or transaction. This includes contracts, decisions at the shareholder and management level, legal obligations of the company and its contractual partners, licenses, signs of legal violations and potential liability risks. The expertise of a specialist lawyer for corporate and commercial law as well as for International Business Law is particularly valuable here, as such a specialist lawyer knows the specific legal framework and challenges. As a lawyer commissioned to carry out a due diligence, I ensure that all relevant legal questions are clarified.
A successful due diligence process often requires close cooperation between an interdisciplinary team. In addition to the lawyer, financial experts, tax consultants and business economists are often involved. Good communication and coordination are essential in order to take all relevant aspects into account. If special legal questions need to be considered, for example at interfaces with labor, tax or insolvency law, I will recommend bringing in appropriate specialist lawyers and experts where necessary.
However, a due diligence lawyer is also important on the seller's side. He must advise the seller on what information and documents are to be disclosed at what point in a corporate transaction and to what extent. He must also ensure that the prospective buyers provide strict confidentiality agreements. Once information has been disclosed, it cannot be undone.
Types of Due Diligence
Legal Due Diligence
Legal due diligence, also called “legal due diligence”, includes the review of all legal documents and contracts. This includes employment contracts, rental agreements, supplier contracts and legal obligations. These include shareholder resolutions, management resolutions and antitrust issuesLegal due diligence is important to identify and assess potential legal risks.
Other species
Tax due diligence examines the company's tax situation in order to identify possible tax risks and obligations. Tax due diligence helps to identify tax pitfalls at an early stage. Financial due diligence is closely linked to this. This type of audit focuses on the company's financial health. Balance sheets, profit and loss statements and tax documents are analyzed. Financial due diligence is essential for assessing the company's economic stability.
Operational due diligence looks at the operational processes and efficiency of the company. Production processes, supply chains, sales and internal structures are analyzed. Operational due diligence provides information about the company's performance. Commercial due diligence examines the company's market position, competitive environment and growth opportunities. It evaluates the market conditions and strategic opportunities.
The Due Diligence Process
Preparation
Thorough preparation of a due diligence is essential. The seller must compile all relevant documents that give the potential buyer an overview and insight into the company. The due diligence lawyer on the seller's side compiles all the necessary information with the help of the seller, usually in a so-called data room. This contains strict access requirements and documents who accessed what and when.
The due diligence lawyer on the seller's side must also ensure that particularly sensitive information such as business and trade secrets, customer lists, supplier conditions and other price-sensitive information is not disclosed to competitors. Firstly, confidentiality must be ensured by strict confidentiality agreements, also known as "non-disclosure agreements" (NDAs). Secondly, it may be necessary for information relevant to antitrust law to be checked by third parties and only made available to the buyer in a summarized form. This is because an exchange of information on price-sensitive or otherwise competitively relevant data is contrary to antitrust law and is being pursued more and more strictly by the antitrust authorities.
analysis and evaluation
The buyer's due diligence lawyer comprehensively analyzes the disclosed data, information and documents and evaluates them legally in order to obtain a complete picture of the company. This includes identifying risks and evaluating opportunities. A due diligence analysis helps to identify the strengths and weaknesses of the company.
Due Diligence Report
The result of the due diligence, i.e. the examination, will be summarized in a due diligence report. It is common practice to mark critical issues as “red flags” in order to draw the buyer’s attention to them. A so-called red flag due diligence helps to identify critical problems at an early stage.
Often the prospective buyer will also inform his due diligence lawyer in advance about key points that are relevant to him.
If the buyer is very concerned about the seller's customer relationships, the due diligence lawyer will pay attention to the delivery conditions, the binding nature of prices, the duration of contracts and termination options.
If key employees are particularly important to the purchaser, he will also place particular emphasis on reviewing employment contracts.
However, for negotiating reasons, the interested party will not disclose to the seller what is important to them. The due diligence report is therefore confidential.
Risks in Due Diligence
Incomplete information
Incomplete or incorrect information can lead to wrong decisions. It is therefore important that all relevant data is thoroughly checked and verified. The buyer's due diligence lawyer must point this out so that the buyer can request more detailed disclosure of information from the seller.
time pressure and hasty decisions
Another common mistake is time pressure. Rushing through the process can result in important details being overlooked. Allow yourself enough time for due diligence to make informed decisions.
underestimation of the costs of due diligence
The cost of due diligence can vary greatly. Factors that influence this include the size of the company, the complexity of the transaction and the extent of the review required. Careful budgeting and planning are essential to keep costs within limits. All potential cost factors should be considered and included in the budget.
Lack of consideration in contract drafting
It is not always possible to resolve identified risks in advance in a corporate transaction. Identified risks must be mapped out during contract negotiations, particularly when drafting guarantees. For all points that are important to the buyer, the buyer will demand guarantees from the seller that these points are met or not met. For example, the buyer may find the seller's guarantee important that certain customers or employees of the company have not terminated their contracts.
The seller is naturally interested in not giving any guarantees, particularly that certain circumstances have not occurred or do not exist. He will therefore point out to the buyer that he was given insight into the company as part of the due diligence and was therefore able to gain knowledge of the circumstances. In this case, a balance of mutual interests must be reached through negotiations.
Technological developments in due diligence
Technological advances such as artificial intelligence and big data are playing an increasingly important role in the due diligence process. These technologies enable a more efficient and rapid analysis of very large amounts of data. However, the final and more precise risk assessment will have to be carried out by specialists because only they know and understand the precise requirements of the prospective buyer.
Conclusion
Due diligence is an indispensable process in corporate and commercial law. A competent lawyer specializing in corporate and commercial law can make a decisive contribution to minimizing risks and making well-founded decisions. Through thorough preparation, the collaboration of an interdisciplinary team and the consideration of technological developments, due diligence can be carried out effectively and successfully. Please feel free to contact me as a lawyer if you have any questions on this topic.
