By John Kalampa
Legal practitioner | Insolvency Practitioner
Legal Due Diligence (LDD) is a comprehensive and wide-ranging appraisal or evaluation of a business. It is usually done as part of a merger, acquisition, or investment before a potential buyer or investor invests acquires or provides funding to a business enterprise or company [target company]. Depending on the purpose and scope of the LDD, it can involve reviewing the assets and liabilities of the target company, corporate structure, operations, and key business relationships. This business guide will provide a simple checklist of some key considerations when carrying out an LDD exercise during a Merger and Acquisition [M&A] transaction
2. Key Considerations/The Checklist
2.1. Corporate and Capital Structure
This encompasses reviewing the target company’s governance structure, capitalization and general corporate records. In particular, the following will be considered: incorporation documents, corporate bylaws, lists of all securities holders, minutes from board meetings, shareholder and executive committee meetings, agreements relating to sales/purchases of the business, credit reference bureau records, checking compliance with the Registrar of Companies, financial statements, credit agreements, debt and contingent liabilities.
Such information is extremely vital because it informs an investor on the target company’s capacity to enter into the transaction i.e., whether its constitution allows it to; the amount of debt and/or equity the target company has; the stage in the business life cycle at which the target company is; and generally checking the target company’s compliance with certain requirements such filing annual returns.
Consider the total value of all the assets and any debts or liabilities against them. The following assets are generally appraised: Real Estate, inventory stock, equipment, technology etc. The review also involves analyzing the documents relating to the assets of the target company i.e. their validity, title, third party interests such as mortgages, charges, security interests etc.
This is done in order to get an accurate picture of the value of the target Company by ascertaining the total value of the assets against all or any contingent liabilities. It also helps verify any representations or other statements made or issued by the target company.
This involves an examination of all material contracts or commitments for instance: customer-supplier contracts, guarantees, loans and credit agreements, agreements of partnership joint venture, equipment leases, settlement agreements, employment contracts etc.
At the end of this exercise, an investor gets a picture of the contractual rights and obligations of the target company; and whether there is pending or potential contractual liabilities.
On this aspect, you generally analyse pending or on-going legal disputes. Active litigation files, including letters asserting claims, complaints, answers, etc, any litigation settlement documents, any decrees, orders or judgments of courts or governmental agencies, and description of any warranty claims which have been made against the target company, any subsidiary, or any partnership or joint venture and the resolution of such claim and Information regarding any material litigation to which the target company is a party or in which it may become involved.
2.5. Competition and Fair Trading
It is imperative to always consider competition and fair-trading issues. The Competition and Fair Trading Act (CFTA) expressly requires that an application for approval be made to the Competition and Fair Trading Commission (the Commission) prior to an M&A transaction. This is because certain M&A transactions, especially those within the same industry or trade, are highly likely to lead to a particular business having monopoly over an industry. To prevent any unfair competition therefore, it is imperative that an M&A transaction be approved by the Commission.
In general, LDD exercise involve a myriad of issues and considerations. This business guide has only provided the general or key considerations. Every LDD exercise however needs to be contextualized such that certain special factors will be reviewed (e.g. intellectual property rights, telecommunications, environmental regulations) to suit the intended purpose and depending on the industry and trade. For more information and/or inquiries, you are welcome to contact the author, using the details provided below.