What You Need to Know About Legal Due Diligence - Acquira

What You Need to Know About Legal Due Diligence

What You’ll Learn
  • What you need to know before due diligence starts
  • The headspace you should be in during the process
  • Post-acquisition services and how your legal advisor can help
  • How to navigate your relationship with your legal counsel 
  • How to keep the legal cost of due diligence down 

Introduction

Due diligence is a vital step in any business acquisition. It’s been mandatory ever since the Securities Act of 1933 came into play.

According to investor.gov, this act basically states two things:

require that investors receive financial and other significant information concerning securities being offered for public sale; and

prohibit deceit, misrepresentations, and other fraud in the sale of securities.

If you want to dive into the details of this act—also called “truth in securities” law—you can read it here.

Many acquisition entrepreneurs are unaware of the treacherous legal complexities that come with carrying out due diligence on a business they are thinking of purchasing.

Before we simplify these complexities for you, let’s bust a common myth in acquisition:

“Getting a dedicated deal team is not necessary. It’s just extra expenses.”

Many entrepreneurs believe in this myth. So they do not contact a legal firm or lawyer until after they’ve signed themselves into some uncomfortable agreements.

The right team by your side will get you:

  • Better valuation
  • Faster deal closing, and
  • Safety from costly mistakes

Instead of shunning experienced legal advice, team up with a legal advisor before due diligence begins. Because it is crucial for the satisfaction and success of the acquisition.

Legal Due Diligence: What Acquisition Entrepreneurs Need to Know Before, During, and After an Acquisition

Recently, we had a group call between our legal team from Aegis Law and participants of the acceleration gauntlet. We discussed several legal topics in business acquisition that you should know.

In this article, we’re pulling highlights from that video to show you what you need to know about the legal aspects of due diligence before, during, and after an acquisition.

Here’s the video, and its content:

00:00 Introduction

5:42 Navigating and mitigating risks for clients buying trade businesses with license requirements

11:23 Inputs and restrictions on how to structure a deal

14:27 Capitalization of debt / Subordination of seller note

25:07 Stock sale vs Asset sale / Best way to limit lawsuits from previous owner / At what point does becoming a corporation make sense?

47:00 How to keep legal costs down during due diligence / Legal aspects AEs should be aware of before, during, and after acquisition

57:21 Provisions in the note that account for transition of ownership

Meet our legal experts on the group call

Jeff Baughman: He practices corporate law focusing on corporate, regulatory, and transactional matters.

Alex Prasad: He is an M&A attorney for early-stage businesses.

Together under Aegis Law, they work with Acquira to assist acquisition entrepreneurs and business sellers close successful deals.

What you’ll learn:

After going through the thoughts and advice of Jeff and Alex, you will be able to understand:

  • What you need to know before due diligence starts
  • The headspace you should be in during the process
  • Post-acquisition services and how your legal advisor can help
  • How to navigate your relationship with your legal counsel 
  • How to keep the legal cost of due diligence down 

Let’s dive in…

Common Legal Pitfalls When Acquiring a Business

Business acquisition might be initiated over coffee, but it is never concluded on the same coffee table. “Entrepreneurs are mostly eager to close the deal, whereas seller’s counsel might love to spend weeks and months on the process” says Jeff.

“Entrepreneurs are mostly eager to close the deal, whereas seller’s counsel might love to spend weeks and months on the process.”

So, how do you speed things up? One excellent way is to avoid these common pitfalls that are scattered all over the due diligence process.

Not knowing what to ask

Understandably, you may be new to acquisitions. And comprehending some technicalities takes time. However, being completely clueless about what’s going on will not take you to a successful close.

As Jeff advises acquisition entrepreneurs, “be upfront about yourself”. You must know what your concerns are so you can ask the right questions.

“Be upfront about yourself.”

Whether you’re performing due diligence by yourself (you shouldn’t do this) or you hired a dream team, what will secure your interest is vigilance and awareness about what you are dealing with.

Are you worried about employment or concerned about the contracts? Or maybe finance is the major issue for you? Make sure you’re aware of these and communicate that to get clarity.

It seems simple enough, but this is where many entrepreneurs fail.

Believing the myth that legal advice is not worth it

If you think that legal advice during due diligence is not worth it and your tax or finance professional is enough to perform the process, you could be making a serious mistake.

The tax and finance professionals will perform checks on the business’s financial records. But there is more to an acquisition than that. Having a legal advisor helps you unravel those vital questions you should be asking that you’re probably not aware of.

Warranties, contracts, agreements, leases, patents, business deals, etc., are just some of the many legal sides to be explored during due diligence. Any one of these tiny moving pieces could make or break your deal.

Incompetent seller counsel 

As Jeff highlighted that incompetent seller counsel can become the number one killer of the deal. “If the seller has chosen a legal person who has been dealing with wills or bankruptcies in his career, it won’t help for acquisition”, says Jeff.

“If the seller has chosen a legal person who has been dealing with wills or bankruptcies in his career, it won’t help for acquisition.”

Additionally, if the seller’s counsel is not aware of laws regarding M&A, SBA guidelines about selling, etc., the experience will be more stressful than it needs to be. He points out that getting the seller the right counsel is an important time and money saver.

Therefore, to avoid this pitfall, build a mutual relationship of trust with the seller. As Alex likes to say, “negotiations are 90% human, 10% legal”.

Overdependence on your legal advisor

“Be clear about your relationship with the legal advisor.”

Alex said, “Be clear about your relationship with the legal advisor.” He pointed out that the entrepreneur is the principal and the lawyer is an agent in the deal. Your lawyer can only do what you authorize them to do. 

You cannot occasionally make a call to your lawyer and ask what’s up about the deal. You are the deal maker or breaker; therefore, your involvement and presence during discussions and matter resolutions are of prime importance.

What to Expect During Legal Due Diligence

Due diligence can become complicated if you don’t know the right attitude to bring to the table. As Jeff says,

“If you are the kind of person who goes with the flow and leaves everything on time, you shouldn’t be in entrepreneurship.”

You have to be proactive to be a successful entrepreneur. Your legal team is going to assist you but you still need to pull much of the weight.

These are some weights you should expect to pull during this stage of business acquisition:

Discussions and visits to the seller to dig out issues

Before the process of due diligence starts, as a prospective buyer, you must make several visits and arrange discussions with the seller to ask “the why” behind the business and intent to sell.

Dig as deep as you can to reveal the reality behind the painted picture. Even if the seller’s counsel and seller are trying to portray a flowery business picture, you can locate the tumor by asking these questions.

Due diligence checklist

Jeff said,

“We kind of arm our clients with due diligence checklists because the most dangerous questions are the ones you didn’t even know to ask.”

Having a due diligence checklist will provide you with a roadmap of what to analyze based on the responses of the seller and their team.

Your relationship with your lawyers

Many acquisition entrepreneurs do not understand the principal and agent relationship with their lawyers. Alex highlights that the success of your acquisition deal depends on how much regard you are paying to your relationship with lawyers.

They are not supposed to make final decisions. Your legal advisor is your coach who will equip you with the tools to take into the deal. Alex added about Aegis law and Acquira,

“We’re going to coach you and get you to the finish line. But we are football coaches, you know, not the running back.”

How to Keep Legal Costs Down During Due Diligence?

You can manage your legal costs during due diligence by following this advice from Jeff:

Build a trustworthy relationship with your seller and help them get the right counsel to deal with things. A bankruptcy-specialized lawyer or will-specialized lawyer should not be dealing with the acquisition. It will save the time of all parties and the costs as most legal advisors charge per hour. 

Instead of going into a full due diligence process, it is better to find the areas of concern you have identified in the initial discussions with the seller. Instead of operating all organs, scanning the area of the problem is cost-efficient and effective. 

Key Takeaways

  • Understand the importance of time in the due diligence process and choose competent legal advice to help you sail your ship
  • Communication and discussion with the prospective seller will be a time saver and help you identify the business issues in-depth from the seller’s response
  • Own your relationship with a lawyer and stay involved during the process

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