There are various reasons investors make an investment without first performing a legal due diligence examination. These include that the contemplated investment is in a young company, there is insufficient budget, or other cost-benefit considerations. Additional reasons include the volume of the investment, timetables, and long-standing work relations between the investors and the corporation.
As a rule, whenever we’ve encountered a decision not to perform a legal due diligence examination before investing, that decision turned out to be wrong.
Undeniably, every investment involves some risk. However, you can mitigate the degree of risk by performing a comprehensive examination of the business being acquired.
Legal Due Diligence Process
A legal due diligence process allows investors to learn about various aspects of the corporation. These include the identities of the corporation’s shareholders; its relations with the banking system; the approvals required from third parties; the corporation’s pledged assets; the corporation’s licenses and the potential impact of the transaction on their validity; the corporation’s workforce and their employment terms, including exposures relating to obligations to its employees, both by law and by virtue of employment agreements; the corporation’s tax exposures; the structure of the agreements with the corporation’s suppliers, including the degree of risk involved in working with a few material suppliers; the corporation’s customer base and the terms of engagement with them; the corporation’s exposure to past lawsuits; and the necessary actions to protect the corporation’s intellectual property rights, including the registration of patents, trademarks, and copyrights.
The outcome of the due diligence examination should have a major impact on the nature of the contemplated transaction. For instance, it may affect the structure of the transaction (share purchase transaction or asset purchase transaction), the transaction price, the representations required of the business being acquired and its owners, the collateral provided to guarantee the investment, the suspensive conditions to consummate the transaction, indemnity clauses, and the mechanism of the investment.
Finally, the results may very well impact the overall decision on whether to proceed with the transaction.
Due Diligence between Competitors
In 2014, the Israel Antitrust Authority published a public statement addressing information disclosures between competitors during the performance of due diligence examinations prior to executing a transaction.
A due diligence examination is essential for the efficient operation of a business. However, there is always concern about competition being compromised because of a due diligence examination performed between competitors. Thus, according to the IAA statement, when conducting due diligence examinations of each other, competitors must carefully and meticulously consider their actions.
The main discussion in the IAA’s foregoing statement targets the tension between the prohibition on becoming party to an unlawful restrictive arrangement and the need for an adequate factual foundation of knowledge to forge a transaction between competitors.
Barnea has extensive experience performing due diligence examinations, including antitrust aspects. The performance of a legal due diligence examination is a critical component of the investment strategy and plays a decisive role in optimizing your bargaining power during negotiations. For more information, feel free to contact us.