If you’re considering buying a business, you should always conduct a due diligence investigation first. Due diligence refers to the in-depth research and appraisal of a company carried out by a potential purchaser.
A due diligence investigation will confirm that the company is profitable and that any information you’ve been given about the business is accurate. Most importantly, it ensures that the company is complying with the law, highlighting any potential litigation issues.
Legal due diligence is an indispensable part of the due diligence process. In this guide, we’ll explain what legal due diligence is and why it’s so important when buying a business. We’ll also explain how it’s carried out and what checks are involved.
What Is Legal Due Diligence?
Buying a business is exciting, but there is always some risk involved. Exercising due diligence helps to minimise this risk by ensuring that the company is a worthwhile investment.
Essentially, due diligence involves a series of checks examining every aspect of a business before closing the deal. There are three main types of due diligence:
- Financial due diligence – this looks at profitability, sales trends, and balance sheets
- Commercial due diligence – this examines the company’s performance in the market and projections for the future
- Legal due diligence – this ensures that the business is complying with all laws and regulations, and highlights potential litigation issues
In many ways, legal due diligence is the most important area of all. Usually conducted by a lawyer, it examines contracts, tax returns, licenses and more.
It’s vital that you follow legal due diligence best practice when buying a business. This applies regardless of the size of the business or the industry it’s in, from corner shops to accountancy firms.
Why Is Legal Due Diligence Important?
Due diligence is not only about ensuring you’re acquiring a viable and lucrative company. Legal due diligence is especially important because it will protect you from unwittingly entangling yourself in any legal issues.
Once you become the owner, any potential liabilities or legal misconduct associated with the business will fall on you. Thus, the consequences of not carrying out sufficient legal due diligence can be severe.
Legal Due Diligence Example
For example, imagine you want to purchase a retail business. You find a clothing store for sale that seems well-run and managed, with a high profit margin.
So, you decide to purchase the company. All is going well for a while – until the business is taken to court for major copyright infringement.
As the owner, you now represent the company and could be held criminally responsible. Along with substantial legal fees, you’re now facing an unlimited fine, or even a prison sentence.
This could have been prevented by exercising legal due diligence prior to acquisition. The examination would have revealed that the business was plagiarising another company’s intellectual property, giving you a chance to back out.
How Do You Carry Out Legal Due Diligence?
As a buyer, it is technically possible to carry out legal due diligence yourself, but we don’t recommend it. The scope of legal due diligence is so vast that it requires significant legal expertise. Hiring an experienced corporate lawyer is the best option.
Your lawyer will put together a due diligence questionnaire for the seller. This is a list of all required legal information and documents. Once the seller provides the relevant documentation, the lawyer will scrutinise it and highlight any concerns.
If you’re buying a company through a professional business broker such as Chelsea Corporate, their legal team will take care of everything for you. An adviser will always be on hand as your point of contact, and you’ll be kept informed throughout.
Legal Due Diligence Checklist (UK)
Conducting comprehensive legal due diligence when buying a business is an enormous undertaking. Absolutely nothing can be missed if you don’t want to risk litigation.
Corporate lawyers have comprehensive checklists encompassing every facet of legal due diligence. Some of the questions they will ask include:
- Is the business registered correctly with Companies House and HMRC?
- What insurance does the business have? Have any claims been made in the past?
- Have all past tax returns been filed correctly?
- Are there any litigation issues (past, ongoing or anticipated)?
- Does the business have up-to-date licenses and permits?
- Is the company complying with all relevant laws, acts, regulatory agencies and authorities?
- Are there any environmental issues to be aware of?
- Is the firm financed? What are the repayment terms?
- Is the business in arrears with any suppliers?
- What patents, trademarks and copyrights does the company hold?
- Are risk assessments carried out regularly?
- What staff policies are in place?
Specific details will vary with each company. The process can take anywhere from days to months, depending on the size of the business and its history.
Which Documents Are Verified During Legal Due Diligence?
Proper legal due diligence involves verifying all legal documents pertaining to the company before the acquisition. For example:
- Business licenses
- Loan payment plans
- Insurance policies
- Contracts (pertaining to service, employees and customers)
- Stockbroker agreements
- Patents, trademarks and copyrights held
- Payroll records and staff files
- Tax records
- Financial records (books)
- Copies of product warranties
There’s a lot to consider, and the above list isn’t exhaustive. An experienced business acquisition specialist such as Chelsea Corporate can help you conduct proper due diligence before buying a business.
Buying a Business? Contact Chelsea Corporate Today
Whether it’s your first time buying a business or you’re looking to expand your portfolio, Chelsea Corporate can help. We are specialist business brokers with a focus on off-market business mergers and acquisitions.
Our skilled team is highly experienced in finding, vetting and approaching profitable businesses before they come to market. We’ll always carry out comprehensive due diligence before you buy, with the help of our legal experts. Though we’re based in the UK, we can even close deals remotely for overseas buyers.
If you’re ready to discover our exclusive database of off-market businesses, contact us today. Fill in our online form or call us on +44 (0) 20 3011 1373. Alternatively, you can email us at firstname.lastname@example.org.