What is Legal Due Diligence?
Legal due diligence is a comprehensive appraisal of a business undertaken by a prospective buyer, particularly to establish its assets and liabilities and evaluate its commercial potential. For entrepreneurs, it is a critical step in the
startup and acquisition process. It involves verifying that the business is compliant with laws and regulations and identifying any potential legal risks.
Why is Legal Due Diligence Important?
Legal due diligence helps entrepreneurs make informed decisions. By conducting due diligence, you can identify any legal pitfalls that may exist within a business, avoid unforeseen liabilities, and ensure that the business is in good standing. This is particularly important when securing
funding from investors, as they will want to know that the business is legally sound.
Key Areas of Legal Due Diligence
Corporate Structure and Governance
Review the company’s
corporate structure, including its articles of incorporation, bylaws, meeting minutes, and records of board and shareholder meetings. This helps ensure that the company is properly organized and managed according to legal standards.
Contracts and Agreements
Examine all significant contracts and agreements, such as
partnership agreements, customer and supplier contracts, leases, and employment agreements. Ensure that these documents are in order and that there are no unfavorable terms that could impact the business.
Intellectual Property
Verify the ownership and status of the company’s
intellectual property (IP), including patents, trademarks, copyrights, and trade secrets. Ensure that all IP is properly registered and protected to avoid future disputes.
Regulatory Compliance
Assess the company’s compliance with applicable laws and regulations. This includes understanding the regulatory environment of the industry, ensuring that the company holds all necessary licenses and permits, and that it is compliant with
labor laws, environmental regulations, and health and safety standards.
Litigation and Disputes
Review any past or ongoing litigation involving the company. Understanding the nature and status of any legal disputes can help you assess potential risks and liabilities.
Financial Due Diligence
Although primarily a financial activity, financial due diligence overlaps with legal due diligence. Review financial statements, tax filings, and audit reports to ensure the company’s financial health is legally compliant and accurately represented.
Questions to Ask During Legal Due Diligence
Corporate Documents
Are the company’s articles of incorporation and bylaws up to date? Are there any discrepancies in the corporate records?
Contracts
Are there any contracts with terms that could be detrimental to the business? Are there any contracts that are due for renewal or termination?
Intellectual Property
Is all intellectual property properly registered and protected? Are there any potential IP disputes?
Compliance
Does the company hold all necessary licenses and permits? Is the company compliant with all relevant laws and regulations?
Litigation
Are there any ongoing or past legal disputes? What are the potential outcomes and implications of these disputes?
Financial Records
Are the financial statements accurate and up to date? Have there been any significant changes in the company’s financial position?
Conclusion
Legal due diligence is a critical component of the entrepreneurial journey. It helps mitigate risks, assures compliance, and provides a solid foundation for making informed business decisions. By thoroughly investigating a company’s legal standing, entrepreneurs can protect their investments and set the stage for long-term success.