Whether a company is acquiring or divesting just assets or an entire business, legal counsel generally assists in four phases before the completion of the intended transaction. The first phase is the preliminary negotiations, which lead, in most cases, to the execution of a letter of intent. The second phase is due diligence. The third phase is the negotiation and signing of the definitive agreement. The final phase is the closing of the transaction.
Following the preliminary negotiations and agreement in principle, due diligence is commenced. This second phase is critical to any business transaction and must be handled in an effective and productive manner, otherwise there can be significant negative consequences, including broken or delayed deals and the exposure of the buyer and seller to unexpected post closing liabilities. Most of these problems can be avoided if the due diligence is properly administered.
Due diligence is understood by the legal, financial and business communities to mean the disclosure and assimilation of public and proprietary information related to the assets and liabilities of the business being purchased. This information includes financial, human resources, tax, environmental and legal matters.
Due diligence serves two roles. For the buyer, it provides the opportunity to confirm the accuracy of the information disclosed by the seller. It also helps the buyer determine whether there are any potential business concerns, including, for example, the assumption of noncompete obligations, questionable receivables, liens on title to the assets, changes of control or assignment restrictions, government approvals or other issues that need to be addressed in the definitive agreement. It also helps the buyer evaluate and plan for the integration of the seller's business with its own.
From a seller's standpoint, due diligence helps the seller ascertain rights that should be retained by the seller, determine any obstacles that could delay the closing and aid in the preparation of the seller's disclosure schedules for the definitive agreement.
In order to attain each party's goals in the due diligence process. the following steps should be taken by responsible counsel.
Steps for the Buyer Before Conducting the Due Diligence
The buyer's counsel should prepare a players list that includes the names, addresses, telephone numbers, fax numbers and e-mail addresses of all the personnel involved for each party and its outside advisers.
Counsel then should coordinate the formation of the due diligence team members for each area of concern, including financial, tax, legal, human resources, environmental and business (e.g., sales and marketing) areas. Also, counsel should designate one member of each team as the point of contact.
Counsel should review any preliminary internal business summaries prepared by the buyer's staff and review and revise the proposed due diligence checklist before sending it to the seller in order to customize the checklist for the current transaction. This step requires input from all due diligence teams.
If possible, counsel should provide the seller with reasonable time to collect and present in an orderly manner the requested information.
Counsel must coordinate the activities of the due diligence teams to provide each with an opportunity to meet and confer with the seller, as well as one another, during the due diligence process, while minimizing unnecessary or duplicative requests that would delay the process. For the legal team itself, counsel must determine which team member is to review each area of inquiry.
Buyer's Steps during the Due Diligence (whether on-site or remote)
Buyer's counsel should conduct an initial overview meeting with representatives of the seller in charge of due diligence. This meeting should provide a general understanding of the seller and of the assets or business to be acquired. The seller's representatives need to advise the buyer as to what information is currently available for review, what additional information will be provided during the due diligence process and how, from whom and when such information was or will be collected.
Buyer's counsel can then proceed with the due diligence review, providing specific instructions to each team member of what is expected to be accomplished by such team member.
It is a good idea to conduct daily status conferences with each due diligence team and send joint issues to other appropriate due diligence teams. For example, the financial team should provide the legal team with a bad debt analysis for the legal team to determine if there are legal disputes with customers that require further examination.
Counsel should finalize notes in a timely manner for inclusion in a written report. To protect against proprietary contamination claims (i.e., improper disclosure or use of confidentiality information) should the deal not be consummated, it is prudent to use fictitious identifiers for the seller's customers and suppliers in the report. In some cases, disclosure of the identities of the seller's customers and suppliers to the buyer's operations people may be unavoidable because of the nature of the matter addressed (i.e., a competitor or a difficult common customer). When actual identities must be disclosed to the buyer's operations people, such disclosure should be made in a supplemental list containing the actual names, which is distributed only to a limited group of people.
Upon completion of the on-site due diligence, counsel needs to prepare a follow-up list of documents that have not be provided by the seller and obtain copies of all documents, whether or not available on-site, that may require further review.
Buyer's Steps after on-site, or off-site Due Diligence
Counsel should create a comprehensive due diligence report for circulation to the other due diligence teams and the responsible parties of the seller. The report requires at the beginning a concise executive summary that highlights areas of material concern and considers responsive actions. The report should include open items for the legal department to further investigate.
Counsel must keep on top of all open issues, including those that are the direct responsibility of the legal department and those that require further action from other due diligence teams. Counsel should carefully review the due diligence reports of the other teams and identify any conflicts with the legal team's report or issues that require further action by the legal team.
It is a good idea to periodically schedule all hands meetings to go over open concerns and issues and establish time schedules for concluding the due diligence.
Counsel can then reflect in the draft definitive agreement the buyer's position on any significant issues identified in the due diligence reports, while communicating the buyer's concerns as to such issues to the seller.
Counsel should compare the information in the due diligence reports with the seller's disclosure schedules. If there is any discrepancy, counsel must promptly communicate the discrepancies with the seller's counsel and the buyer's business team.
Counsel should conduct independent Uniform Commercial Code, litigation, state corporation and other governmental searches, including patent copyright, trademark and domain name searches.
Counsel should also participate in internal integration meetings with the knowledge gained from the due diligence efforts.
If the transaction is not completed, counsel should collect all due diligence materials from all team members, including information provided by the seller and analysis and reports prepared by the buyer, and depending on the terms of the confidentiality agreement or letter of intent, either archive all such materials, or index all of the seller's information for archival purposes and promptly return to the seller all materials provided by the seller.
Steps by the Seller Prior to Commencement of Due Diligence
The seller's counsel should assist the buyer's counsel in the preparation of the players' list and ascertain and review the materials that have already been provided to the buyer.
Counsel should review the buyer's due diligence request list and determine with department staffs if any requested information is not applicable to the transaction or is unreasonably burdensome to produce under the circumstances, taking into account the scheduled closing date. Any questionable queries should be immediately addressed with the buyer's counsel.
It is a good idea to create file folders that are coordinated with the due diligence request list. Counsel should review all documents prior to their inclusion in the file folders for appropriateness and completeness and place a confidentiality mark on each proprietary document. Also, counsel needs to determine if any of the documents intended to be disclosed are subject to any confidentiality restrictions that require the consent of a third party prior to disclosure. The legal department should also begin examining all relevant third party agreements for change of control and assignment restrictions. It is smart to identify in the file folders any documents that are being collected and will be added.
Counsel should create at least two complete sets of the disclosed materials. One set should be provided to the buyer's due diligence team. The second set should be retained by the seller's outside counsel in case of any future disputes and for various post closing purposes.
Counsel should coordinate and designate the employees who will respond to oral queries from the buyer's due diligence teams.
Seller's Steps during the Due Diligence
Counsel should moderate and participate in the initial all hands overview meeting and schedule and participate in periodic meetings with the seller's internal staff to determine the progress of the due diligence. Counsel also should schedule and participate in periodic meetings with the buyer's due diligence teams to determine if there are any issues that have been identified by the buyer and provide the buyer with the status of any open items.
Counsel should confirm which outstanding documents need to be provided to the buyer's due diligence team prior to its departure from the due diligence location.
Counsel should conduct Uniform Commercial Code, litigation and appropriate state and federal searches in order to confirm the accuracy of the specific disclosure schedules.
Buyer's Steps after Due Diligence
Counsel should prepare and review the schedules for the definitive agreement using the disclosure file folders, for confirmation. Then, counsel can ascertain if any rights or other assets need to be retained by the seller and address such issues during the negotiations of the definitive agreement.
If the transaction is not completed, counsel should enforce the seller's rights, if any, under the confidentiality agreement or the letter of intent regarding the return, archival or destruction of the due diligence materials of the seller and the buyer.
The basic steps suggested above are neither exclusive nor appropriate in all circumstances but merely intended to assist counsel in achieving the ultimate objective of due diligence; the gathering and disclosure of all germane information to enable each party to fully understand the business or assets being purchased and sold. If this goal is achieved, there is greater likelihood that both parties will be satisfied with the deal that they have made.
|Paul S. Anik is of counsel at Mitchell, Silberberg & Knupp and specializes in business transactions for high tech companies. Daniel Freedman, formerly with this firm, and James Weiss, associate at the firm, respectively, assisted in preparing this article.|