Legal Due Diligence is Vital
Legal due diligence is important.
The function of due diligence is to evaluate the business you’re acquiring and the risks and pitfalls you’re inheriting by purchasing the business. The extent of legal due diligence conducted could be a game changer especially if issues are caught during the due diligence process and accounted for as part of the purchase agreement.
One issue to look out for during legal due diligence is the “liabilities stack.”
You want to make sure that the terms of the contracts that your target business has entered into aren’t full of unknown liabilities. For example, maybe a supply agreement has a 120-day payment clause, and there’s an account with a lender to buy the goods. Maybe that account with the lender hasn’t been reviewed during the due diligence, and you completely overlook the existing liability.
Another potential example of an issue could be around QA/QC for businesses that deal with goods, like a car part supplier. Maybe one of the existing contracts has issues around terms governing the QA/QC period. Could be an unreasonable QA/QC period which disables you, for example, if there isn’t a reasonable QC period. You could be stuck with defective goods, and wouldn’t be able to remedy the liability and mitigate by pursuing legal action against the seller.
You would want to review remedies and rules for curing and make sure your ability to control the supply chain lines up with your sales contracts and agreements.
Another potential example – let’s say you’re purchasing a SaaS business. The SaaS business has certain tools that are very expensive and on demand to provide output for customers. If one supplier suddenly changes their pricing, and they’re the only vendor for that good or service, but you’ve guaranteed pricing for certain clients, now you’ve bought yourself into breach of contract, and your contracts with your customers don’t limit your liability to consequential damages – you just potentially bought a company that could go bankrupt because of that liability.
The question that your M&A deal lawyers are and should be considering when evaluating your target acquisition is: can the business continue under the rights and obligations with the suppliers and customers?
Did you find this post helpful? What questions about the legal M&A process do you have for me?