Whether it's a company sale, a financing round orsuccession planning – as soon as a company changes ownership or a new investorjoins, an important question arises: How well do you really know the legal andeconomic starting position of the company? This is exactly where due diligencecomes in. It makes visible what would otherwise remain hidden and forms thefoundation for viable decisions in transactions.
Sound due diligence is essential in M&Atransactions. It provides both sides with clarity about liability risks,ownership and regulatory obligations. Buyers or investors can make informedinvestment decisions, while the seller or target company creates trust andsecures the value of their company with careful preparation.
What is legal due diligenceand when does it make sense?
Legal due diligence (LDD) is a specific sub-area ofdue diligence that focuses on the legal aspects. In contrast, financial duediligence, for example, focuses on financial key figures and commercial duediligence on market and competition analyses.
LDD thus refers to the structured examination of alllegally relevant documents and facts of a company. It is usually carried outafter an initial expression of interest (a so-called letter of intent) or at the beginning of the actual transaction.For buyers, this means recognizing risks and having them hedged by reps and warranties, as well asnegotiating the purchase price. For sellers, this means resolving possiblestumbling blocks at an early stage and creating transparency in order to makenegotiations more efficient. In both roles, LDD is therefore a crucial tool foravoiding surprises and achieving one's goals in the best possible way.
This is how legal duediligence works at a glance
1. Scoping andMateriality Threshold
At thebeginning, the scope and priorities of the examination are determined. Whitinthis stage, regularly the so-called materialitythreshold is established – a threshold value above which risks orirregularities in the documents are considered substantial for the transaction.This threshold helps to make the LDD efficient by examining only relevantaspects in depth. This threshold is determined by agreement between the partiesand is based on the significance of the respective risks for the transaction.
2. Due diligencechecklist & data room
This stepis followed by a thematically structured due diligence checklist. This servesas the basis for the provision of the relevant documents, which are collectedand provided in a structured manner in a virtual data room (VDR).
3. Analysis & RedFlags
Theadvisory team reviews the documents and identifies possible red flagssuch as unresolved ownership, missing permits or ongoing judicial or officialproceedings.
4. Reporting & recommendations for action
Theresult is a report with recommendations for action, which serves as the basisfor the next negotiations.
What documents are part ofthe due diligence process?
Business Capital
The founding documents, articles of incorporation,excerpts from the commercial register and the share register including thecomplete chain of title must bechecked, i.e. whether the previous transfers of shares are without gaps andcomplete. Shareholders' agreements, subscription documents and thedocumentation of previous financing rounds, such as Cap Table, play an important role.
People
Employment agreements, bonus or participation plans aswell as agreements with key people are central. Issues such as change-of-controlclauses, non-competition clauses or IP rights to inventions must betransparent. The examination ofwhether all social security contributions have been paid is also part of theLDD, otherwise a liability risk arises for the future owners.
Assets
Inventories, leasing contracts and, in particular,real estate documents (land register extracts, encumbrances, liens) are amongthem.
IP & IT
Patents, trademarks, licenses, domain rights and ITcontracts are not only important for technology-oriented companies.
Corporate Governance& Finance
Annual financial statements, audit reports, budget andfinancial plans, minutes of the Annual General Meeting and the Board ofDirectors, bank receipts, tax documents and tax returns belong in every LDD.
Other
Approvals, general terms and conditions, customer andsupplier contracts as well as ongoing proceedings round off the review.
The importance of legal duediligence in business succession
Careful LDD is also of central importance in thebusiness succession of SMEs, especially in the case of an MBI or a sale tothird parties. It enables the prospective buyer to gain a comprehensiveunderstanding of the legal structure of the company and to identify potentialrisks at an early stage. This is crucial to making informed decisions andmaking succession successful.
For the person handing over the company, the LDDoffers the opportunity to present the company in a transparent light. Byproviding complete and structured documentation, trust and credibility can bebuilt, which facilitates the sales process and minimizes potential legaldisputes.
Overall, a thorough LDD helps to optimize the handoverprocess, minimize risks and create the basis for successful businesssuccession. It is therefore an indispensable tool for both parties toeffectively manage the legal aspects of the business transfer.
Result
The LDD is a central component of every transactionand corporate succession. It is often more extensive than initially assumed.Both buyer and seller benefit from a structured review of all relevantdocuments.
From corporate law to employment relationships and IPto taxes – what emerges from this and is also confirmed in practice is that anLDD is complex due to its many facets, but also indispensable. Whether you needa complete review of all subject areas or are looking for specific support withindividual questions, we are happy to be available to our clients as a sparringpartner.
