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One of the post-MOU in M&A procedures is Due Diligence (“DD”). A brief description of DD is an investigation into the target company, one of the components of M&A. It starts with organizing the facts and risks that are basically publicized or may be identified through DD, evaluates the facts and the risks, and then takes necessary actions.
DD can be categorized by the subject and field. Legal DD performed by attorneys from a legal point of view, financial DD and tax DD performed by accountants are general types of DD, and there are labor DD, environmental DD, and technical DD, which are performed more professionally in specific fields.
Finding and evaluating the risks through Legal DD and taking the necessary actions will be important bases for later procedures, like a negotiation of M&A contract and a decision on purchase price, therefore its importance in the entire M&A procedures is very significant.
The success of M&A is up to whether it is possible to find hidden risks, assess and evaluate the risks properly, and take necessary actions. I think it depends on the skills of M&A lawyers.
Here, let’s look into what Legal DD is in accordance with the sixth principle.
As mentioned earlier, Legal DD is performed by attorneys, but it can be considered by the perspective of the parties to M&A. Basically, Legal DD is performed by the buyer side, but sometimes the seller side performs Legal DD to identify and prepare for risks. In this case, the seller’s DD report (Vendor’s report) is provided to the buyer as DD data.
Legal DD is usually performed after NDA or MOU (or LOI) is signed. In some cases, DD may be conducted several times. For example, in the bidding procedure, there are a preliminary Legal DD which is conducted before the execution of M&A contract and a confirmatory Legal DD which is conducted right after the execution. Sometimes, both can be conducted before the execution of M&A contract. Regarding the confirmatory DD before the execution of M&A contract, the seller gives the buyer an opportunity to decide whether to sign M&A contract.
I’m not sure whether there is a clear distinction between the preliminary DD and the confirmatory DD in practice. But, when the parties agree to do a confirmatory DD after the execution of M&A contract, generally they agree with the closing of M&A unless the material and critical risks are found and agree with the purchase price adjustment or indemnification for other risks.
Basically, Legal DD is often performed in attorney’s office. This is because most Legal DD is performed by reviewing the data sent by the seller via emails or uploaded by the seller via virtual data room.
However, in the case of materials with a high confidentiality, it may be provided via physical data room or restricted from downloading, screen capture, and printing from virtual data room. In case where confidentiality is very important, all data may be provided via physical data room alone. I performed Legal DD of M&A between public companies via physical data room only at a place where a few people know.
Mostly Legal DD targets governance, shares, permits, assets, intellectual property, contracts, labor and employment, insurance, litigation, environment, safety, and health relating to the target company of M&A.
However, the important thing is that Legal DD should not be done only on the data provided by the seller. Basically, you must find and review public materials and sometimes issues from rumors or news articles. Also, you must request for additional information to find issues and risks by considering various circumstances comprehensively.
As for how Legal DD works, it can be largely divided into aspects of time flow and content.
First, in terms of time flow,
(1) Request for Data and review of the data provided accordingly,
(2) Request for information, interview employees of the target company, and review the data provided accordingly, and
(3) Q&A Session - Management Presentation (MP) Session and Site Visits.
In the past, it was common to give a month, but these days it seems to be getting shorter.
The content of the Legal DD conducted in the above flow is reported to clients in the manner of Daily/Weekly Report and Interim/Final Report. Generally, clients request only the Weekly Report, but sometimes they request Daily Report as well. The Interim report is usually made before Q&A sessions, and the Final report is made after all sessions. In some cases, clients request only the Final report.
On the other hand, Legal DD can be considered as (1) facts and risks, (2) evaluation, and (3) necessary actions based on the evaluation.
If someone ask me the reason for conducting Legal DD, I would say “(3) necessary actions based on the evaluation”. It is to decide whether to do M&A or not.
In addition, it is to establish, modify, and decided the deal structure through Legal DD, and to determine and adjust the purchase price to find out what can be reflected in the valuation of the target company.
Also, it is to decide the contents of M&A contract. Specifically, the actions for risks identified through Legal DD is to prepare, modify, and review the contents of “Representation and Warranties”, “Covenant”, “Conditions Precedent”, and “Indemnification” in the contract.
Finally, it is to understand the situation of the target company in preparation for the operation after M&A, so-called PMI (Post-Merger Integration).
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