Legal Due Diligence: Legal Safeguarding in Business Acquisitions

Legal Due Diligence is a central component of the acquisition process when purchasing a company. Its purpose is to thoroughly examine the legal circumstances of the target company and identify potential legal risks and liability traps for the buyer. Thus, Legal Due Diligence forms an important foundation for the purchase decision and contract drafting.

Classification and Objectives of Legal Due Diligence

Legal Due Diligence is part of the broader Due Diligence review, in which a company offered for sale undergoes a comprehensive analysis. In addition to the legal review, Due Diligence typically also includes an examination of the economic, tax, and financial conditions of the target company, often referred to as Business Due Diligence, Tax Due Diligence, and Financial Due Diligence.

The objective of Legal Due Diligence is to provide the buyer with as complete and transparent a picture as possible of the legal situation of the target company. This particularly includes identifying and assessing legal risks that could diminish the company’s value or lead to liability claims against the buyer after the acquisition.

Based on the findings from Legal Due Diligence, the buyer can make an informed decision on whether and under what conditions to acquire the company. The results also feed into the structuring of the purchase agreement, for example in the form of warranties, representations, or indemnities provided by the seller.

Scope of Legal Due Diligence

Legal Due Diligence covers all legally relevant aspects of the target company. Typical areas of review include:

Corporate Law Matters: This involves the ownership and shareholding structure of the company, the composition and powers of management and shareholder bodies, as well as the contents of corporate charters and articles of association.
Contractual Relationships: A key focus is the review of the company’s material contracts, such as those with customers, suppliers, landlords, or licensors. This includes examining validity, termination rights, transferability, and potential risks.
Employment Law Aspects: Legal Due Diligence also scrutinizes the employment relationships within the target company. This includes reviewing employment contracts, works agreements, collective bargaining agreements, pension commitments, and any labor disputes.
Intellectual Property and Industrial Property Rights: Of particular interest are patents, trademarks, copyrights, and licenses that the company owns or depends on. The review assesses whether these rights were validly acquired and remain enforceable.
Public Law Permits: Legal Due Diligence also covers any regulatory approvals and obligations the company is subject to, for example regarding production, environmental protection, or occupational safety.
Compliance and Liability Risks: Finally, it examines whether the target company complies with all relevant legal regulations and whether there are any liability risks arising from contractual breaches, product liability, or other third-party claims.

The exact scope and depth of Legal Due Diligence always depend on the specifics of the target company and the particular transaction context.

Legal Due Diligence Process

Legal Due Diligence is usually conducted by specialized attorneys representing the buyer, often in close coordination with auditors and tax advisors. The process typically consists of the following steps:

Request and Review of Documents: Initially, the buyer’s advisors request all legally relevant documents and information from the target company. These are made available in a virtual data room and reviewed by the experts.
Interviews and On-Site Visits: Additionally, interviews with management and other key personnel of the target company take place. Site visits to operational facilities may also be part of the review.
Analysis and Reporting: The gathered information is analyzed by the advisors and summarized in a written Due Diligence report. This usually includes a presentation of the examined facts, a risk assessment, and recommendations for the buyer.
Measures and Contract Structuring: Based on the Due Diligence results, any necessary risk mitigation measures are taken, and the findings are incorporated into the drafting of transaction documents, especially the purchase agreement.

The entire Legal Due Diligence process often spans several weeks or even months, depending on the size and complexity of the target company and the volume of documents to be reviewed.

Challenges and Success Factors

Conducting Legal Due Diligence often involves particular challenges:

On the one hand, it is essential to maintain an overview amid the abundance of documents and information and to identify the truly material legal aspects.
On the other hand, advisors often face tight deadlines, as Due Diligence runs concurrently with ongoing contract negotiations.
Lastly, it is a challenge to prepare and communicate the legal findings in a way that is understandable and actionable for the buyer, who is typically not a legal expert.

To address these challenges and ensure an effective Legal Due Diligence, the following success factors are especially important:

Experience and Specialization of Advisors: The attorneys conducting Legal Due Diligence should have extensive experience in transaction advisory and detailed knowledge of the target company’s industry.
Close Coordination within the Advisory Team: Smooth communication and collaboration between legal, tax, and financial advisors is essential to avoid duplication of work and to achieve a consistent overall picture.
Thorough Preparation and Structuring: The more carefully Due Diligence is prepared and the clearer the review procedures are structured, the more efficiently the process can be conducted. Standardized request lists and clearly defined reporting formats have proven effective.
Prioritization and Materiality: Given limited time budgets, it is crucial to focus on the points that are truly relevant to the purchase price. Not every legal detail carries equal weight for the transaction.
Trustful Communication with the Seller: Finally, the success of Legal Due Diligence also depends on cooperative and trustful collaboration with the seller. The more transparent and goal-oriented the information exchange, the better for both parties.

Legal Due Diligence plays a key role in the transaction process when acquiring a company. It creates transparency about the legal conditions and risks of the target company and is thus an indispensable foundation for the purchase decision and contract structuring.

For the buyer, a thorough and expert Legal Due Diligence is essential to avoid unpleasant surprises after the acquisition and to generate long-term value from the transaction. Early involvement of experienced transaction attorneys is therefore a must for every business acquisition.

A comprehensive step-by-step guide to conducting Due Diligence can be found in the article "Step-by-Step Guide to Conducting Due Diligence".

Legal Due Diligence