What is Legal Due Diligence (Legal DD)? Explanation of purpose, flow, and checklist

Legal Due Diligence" is an indispensable investigation in corporate M&A. This section explains the contents, objectives, and checkpoints of Legal Due Diligence, which is an important investigation for a successful M&A.

Meaning of Due Diligence

Due Diligence is an investigation conducted in the course of an M&A transaction. It means that the acquiring company conducts a preliminary investigation of the actual situation of the seller's company before signing a contract. This section explains the basics of due diligence, including the types and contents of due diligence.

What is Due Diligence?

Due Diligence is a term that is directly translated as "Due (to be done)" and "Diligence (obligation/effort). In order to make the right decision regarding price and transaction, we thoroughly investigate the financial and operating conditions, IT environment, and various other aspects of the target company.

Types of Due Diligence

There are several types of due diligence. The following is an overview of the characteristics and differences between the main types of due diligence.

Sell-side Due Diligence
Due diligence is generally performed by the buyer side, but sell-side due diligence is performed by the seller side. This is to maximize the sale value and to ensure that the M&A process proceeds smoothly to completion.

Business Due Diligence
Business due diligence is an investigation to confirm the target company's business model, trading conditions, technological capabilities, competitors, and overall market potential, etc. It evaluates the value of the company after the M&A is completed and the overall market that encompasses the company, and assesses the appropriateness of the transaction price.

Financial Due Diligence
Financial due diligence investigates the corporate value evaluation of the financial aspects of the target company, such as how much the assets would be if they were valued at market value, whether the financial statements and other documents represent the actual situation, and so on, based on the financial information of the target company. Since the financial condition of a company has a significant impact on M&A, it is necessary to investigate the company's financial condition with an eye to its future after the acquisition.
Legal Due Diligence
Legal due diligence investigates legal risks, such as whether contracts and transactions entered into by the target company are legally compliant, whether the necessary permits and licenses for the business have been properly obtained, and whether the target company is the subject of litigation due to patents or ownership rights. The purpose is to understand in advance whether there are any risks that may affect the business plan after the acquisition.

Human Resources Due Diligence
HR due diligence investigates human resources and labor issues, including changes in compensation and evaluation systems due to M&A, and risks of personnel outflow due to the integration of personnel systems and organizations, and whether business can continue smoothly after restructuring.

IT Due Diligence
IT due diligence investigates the use of software, the status of IT investment costs, and the integration of management systems. This investigation is conducted to gain an overall picture of IT-related assets and IT strategies while understanding both the business and the system, and to plan for the selection of systems to continue to be used and system migration.

What is Legal Due Diligence?

Among the many types of due diligence, we focus on legal due diligence. Its importance and purpose are explained in detail.

What is Legal Due Diligence?

Legal due diligence is a type of due diligence that focuses on the legal aspects of a company. It examines the target company's shareholder relations, organizational status, contractual relationships with affiliated companies and business partners, assets and liabilities, permits and licenses, and so on. The presence or absence of any legal problems or obstacles, such as compliance with laws and regulations and litigation risks, are confirmed.

Purpose of Legal Due Diligence

Legal due diligence is an important process for a buyer company to avoid risks involved in an acquisition. If major legal issues are discovered, the M&A may be called off. Even when an acquisition is agreed to, legal due diligence is an important factor to consider when negotiating a price that takes into account the legal issues uncovered.

Main items to be investigated during legal due diligence

The following is an overview of the main items to be investigated during legal due diligence.

Contents about the contract

The contents of individual contracts are reviewed to determine if there are any disadvantageous items or legal issues. Particular attention should be paid to change-of-control clauses (COC clauses * conditions under which the contract is changed or terminated in the event of a change of control). We investigate with a view to post-acquisition business operations.

Details regarding assets and liabilities

Investigate the business assets that will be used after the M&A execution. Types of assets include real estate, movable assets, intellectual property, financial assets, and systems. For liabilities, we will also assess the status of borrowings and investigate whether there are any clauses that will be affected by the M&A.

Compliance with Laws and Regulations

Violation of laws and regulations is an important matter related to loss of corporate value. We check for compliance with various laws and regulations, not only with respect to operations, but also with respect to the Companies Act, tax laws, and labor-related laws. The Personal Information Protection Law and the Subcontract Act are also items to be checked.

Contents about Licenses and Permits

Depending on the nature of the business, it may be necessary to obtain permits and licenses, and if the permits and licenses cannot be transferred after the M&A, it will be necessary to reacquire them, but it takes a certain period of time from the application to acquisition. It is important to investigate whether or not the permits and licenses can be transferred, as failure to smoothly reacquire them will affect the continuation of business operations.

Contents about labor

Since employment will continue after the M&A, we will carefully investigate any possible violations of laws and regulations, such as unpaid overtime. While personnel and labor matters are also involved in personnel due diligence, legal due diligence will confirm employee working conditions and working environment issues such as resignation and dismissal.

Legal Due Diligence Flow

The following is a step-by-step explanation of the general flow and content of how legal due diligence is conducted.

Request for Disclosure of Documents

A request is made to the target company for disclosure of materials necessary for legal due diligence. In order to obtain the highest possible purchase price, the seller company will not proactively submit information that would be detrimental to its own interests. A list of required materials is prepared in advance, and requests are made according to the items listed.

Confirmation of disclosure documents

Once the materials are disclosed, the buyer will review and analyze them. The contents of the vast amount of materials are scrutinized and reviewed, requests for disclosure of additional necessary materials are made, and a Q&A list is prepared for any unclear points or questions. We are prepared to confirm the information through interviews and other means.

Q&A with management and on-site investigation

Interviews and interviews are conducted with the target company's management and employees. This is an important procedure to grasp information that is not available in documents, such as earnings forecasts, management policies, and general company matters. By visiting the headquarters and other local offices, we also confirm documents that can only be viewed locally.

Interim and Final Report Meetings

At the interim debriefing, we report findings from the investigation up to this point and closely examine the need for additional investigation. Subsequent actions and whether or not to implement M&A will be discussed. Based on the information reported at the interim debriefing, the missing materials are analyzed and issues are sorted out, and a final debriefing is held among the parties involved.