Due diligence is a process of comprehensive review and evaluation of issues, drawing conclusions pertaining to the subject under scrutiny. In an M&A transaction, due diligence is a process of comprehensively assessing the business operations, assets, finances, commercial advantages, capacity and performance of the target company before the parties formally enter the transactions. One of the indispensable types of the due diligence process is Legal Due Diligence.
Legal Due Diligence is usually performed by a professional team of attorneys and paralegals (“Due Diligence Lawyers”). The result of legal due diligence is the Legal Due Diligence Report, which will objectively assess past compliance to the law of the Target Company, and risks that may arise in the future, such as administrative fines, lawsuits, project withdrawal, etc. The Legal Due Diligence Report results may directly affect the Investor’s decision; therefore, both Investors and Target Companies need to diligently prepare before and during the legal due diligence process.
1. Why should the Target Company perform its own due diligence?
From the perspective of the Target Company (the seller in an M&A transaction), due diligence, in general, and legal due diligence, in particular, is an activity that should be given hefty consideration and performed regularly whether you are planning to sell your business. By assessing all legal issues of the business and comparing its compliance to applicable laws, the results of the legal due diligence process force business owners to have a more substantial point of view regarding their business and its operations and even consider ways to improve or completely change certain aspects of the business.
While doing business, before deciding to invest, the Investors will first perform many due diligences to identify the status of the Target Company. Depending on the specific business of each Target Company and the investment purpose, the Investor will decide which sector should be inspected, such as legal, finance, tax, technical, etc. After considering, and evaluating the due diligence reports, the Investor will decide whether to invest or not, determine the value of the Target Company and choose appropriate investment methods. Therefore, when you are planning to put your business up for sale, legal due diligence becomes even more of an activity that should be performed as soon as possible. By understanding the values and strengths of your business, as well as addressing weaknesses whilst being prepared for inquiries from potential buyers, you can offer your business for sale in top condition and achieve the highest possible negotiable outcome. The negotiation process would not only be easier but also closed faster if the risks associated are correctly identified.
2. 02 notes for sellers in legal due diligence of M&A transactions
Firstly, prior to conducting an M&A transaction
One serious mistake usually made by the Target Company was not conducting a thorough review of its legal documents prior to entering into an M&A transaction. This leads to many documents being unable to be provided to the Due Diligence Lawyers, grave legal errors yet to be rectified, or unnecessary “ludicrous” errors. Consequently, the Legal Due Diligence Report would record contents that would be considered violations of the law, at risk of legal breaches, etc. Thus, the Target Company is advised to actively review all legal issues and correct its shortcomings (if any). The Target Company should pay attention to the following key issues:
It is necessary for the Target Company thoroughly reviews the legal documents that illustrate the Capital Contributing Members/Shareholders as owners of the Target Company, proves they have contributed capital in full and in accordance with the law, or prove the previous purchases of the Equity/Shares were legally performed. This is a particularly important document for Investors to consider whether Capital Contributing Members/Shareholders are entitled to transfer their Equity/Shares or not, or whether Capital Contributing Members/Shareholders are entitled to decide to receive additional capital into the Target Company or not.
2. Line of Business
It is necessary to determine which lines of business the Target Company operates and whether said business lines are conditional, then determine whether the Target Company has met the prescribed conditions yet, and has applied for licenses/certificates according to the law to be able to do such business legally or not.
In addition, in case the Seller wishes to raise investment capital from a Foreign Investor, the Seller needs to consider whether the current business lines of the Target Company allow Foreign Investors to invest. If there are restrictions, the Seller should devise plans to remove/limit such restrictions or give up on calling capital from the foreign investor (only call for capital from Vietnamese investors).
3. Vital Assets
Vital assets can be assessed based on various criteria depending on the business line of the Target Company. Below are some specific types of assets considered vital:
- Real estate: this is a property of great value, which is mandatory to be registered with a competent state agency. The Target Company has to make sure whether the Certificate of Land Use Rights and ownership of houses and land-attached assets have been fully provided, land-attached assets such as factories and other constructions have been completely constructed and fully registered with the state agency or not.
- Intellectual property rights: Intellectual property rights are one of the legal property rights as prescribed by law. The identification and convert intellectual properties into legal assets is one of the measures to increase the Target Company’s property, thereby helping to increase its value. Per said reasons, the Target Company must review the intellectual property of its business and register/apply appropriate protection measures in accordance with the law to turn intangible assets into tangible and commercially exploitable property rights.
Depending on its operation characteristics, each Target Company would consider and focus on issues deemed vital when conducting an M&A transaction, thereby studying and completing legal issues.
Secondly, whilst performing the legal due diligence
To conduct the legal due diligence, Due Diligence Lawyers will request the Target Company to provide legal documents relevant to its business activities. Based on the legal documents provided, the Due Diligence Lawyers shall review and evaluate these documents to prepare a Legal Due Diligence Report.
Careful preparation is essential when the Target Company provides requested documents to the Due Diligence Lawyers, ensuring the complete and truthful provision of these documents would limit the potential risks and violations in terms of incomplete or dishonest records which affect M&A transactions, liability for damages and penalties for contract breaches.
Noteworthy issues for Target Companies: While performing due diligence for any purpose, apart from the said issues in each phase, the Target Company should pay attention to the followings:
- Clearly establish due diligence objective and desired outcome.
- Make sure effort to provide complete and accurate information to consultants.
- In addition to legal matters, due diligence should also be carried out in other aspects of the business to get the most comprehensive view.
- Recommendations for adjusting or supplementing shortcomings in the due diligence reports should not be ignored.
The due diligence of the Target Company is the process of determining and valuing a company. Due diligence can reveal strengths and weaknesses that Investors need to know before acquiring a company, it also allows the seller to address weaknesses and prepare for inquiries from potential buyers. In other words, conducting the due diligence helps sellers ensure that their business is ready for sale, and helps business owners prepare for worst-case scenarios and formulate contingencies.
Disclaimer: This article is for general information only and is not a substitute for legal advice. Apolat Legal is a Vietnamese law firm with experience and capacity to advise on matters related to M&A. Please click here to learn more about our services and contact our lawyers in Vietnam for advice via email email@example.com.