Buyers often value a target company using a market-based multiple of EBITDA (earnings before interest, taxes, depreciation and amortization) or a present value model such as discounted cash flows or discounted residual income. Legal due diligence may provide other useful information about events that have affected historical earnings or events that may affect expected future earnings, cash flows or residual income. This due diligence information can be useful to the buyer to create a more robust valuation of the target transaction. Legal due diligence is important for many reasons, but most importantly, to make informed business decisions. While a list of important questions leads directly to the heart of due diligence issues, there are two potential problems with this approach. First, if a materiality level has been established, there may be a risk of neglecting significant issues that may not have a quantifiable impact on the business or that may have an impact that is not measured solely in dollars. Possible examples are critical issues that are strategic, cultural or reputational in nature. Second, a list of key questions may not be very user-friendly in itself, as the questions may not be clearly understood without a more detailed explanation of their fuller context. To address these two issues, external counsel often produce reports that include a list of significant issues in the summary and a more complete description of the documents reviewed and other issues (that may not meet the materiality threshold) downstream. Some of the details of the legal due diligence process are discussed below. The world of legal issues is too complex to be left to chance. By conducting a thorough LDD, you give your acquisition every chance to create long-term shareholder value. Definition of duty of care: The concept of due diligence in German law refers to the application of due diligence in business transactions.
Due diligence involves a careful examination of the economic, legal, fiscal and financial situation of a company or individual. These include aspects such as turnover, ownership structure and possible links to forms of white-collar crime such as corruption and tax evasion. Such an audit is necessary as soon as a company establishes relationships with business partners or plans to acquire another company or property or invest and do in real estate. Some buyers may be reluctant to exercise due diligence because they may not be able to successfully claim damages for a breach of the representation or warranty if they were aware of the relevant circumstances before signing the transaction documents. In such circumstances, it may be difficult for the buyer to prove that he has suffered damage as a result of the breach. The seller submits that the buyer should have taken this information into account at the price it was willing to pay. It is important to select external legal counsel who have extensive experience in legal due diligence and M&A transactions. Ideally, they also have relevant experience in the target company`s industry. For example, due diligence for an oil and gas exploration company is a very different exercise than due diligence for a computer software company. Any due diligence requires some understanding of the legal architecture common to each type of business.
Whether intentional or not, owners, managers, employees or researchers can influence the results of legal due diligence. This influence can affect the outcome of legal due diligence. Having recognized the value of legal due diligence, the question arises of how to do it and what tools to use. Due to the extremely complex nature of international and local economic transactions, no analytical method as such can be recommended. One approach is to ask the target organization a series of questions about its overall financial position, operational risks and risk management practices. Another method is to ask the seller to make representations and warranties in the commercial contract. The third approach is to audit the financial statements of the seller`s company, as well as examine the legal concerns associated with the transaction. The results of a legal due diligence are really only important for a buyer and the buyer`s legal counsel. It is important to determine who should review the report or rely on it to decide what type of report you need. Do you have financiers who have to rely on your external advisor`s due diligence report to make loans? Do you expect to need coverage and liability insurance, in which case the insurer will want to review the report and possibly rely on it as well? To ensure that only one type of report needs to be produced, it would be important to understand from the outset how the report should be used.