Legal Due Diligence for Seller
DUE DILIGENCE FOR BUSINESS SELLERS: WORKING WITH YOUR ATTORNEY
You upload key documents and information into an online data room, but more is needed. Your attorney, helping with the Purchase Agreement, can also assist with due diligence by reviewing, organizing and responding to the requests of the buyer’s attorney. Even with help, however, it often happens that you receive further due diligence requests and then further ones in what may seem like an endless barrage of emails. At the same time, you are typically dealing with increasing demands on your time (and on your staff's time) as the closing date approaches. How do you handle these requests while you finalize the terms of sale, run the business and, not least, try to maintain some sanity?
February 15, 2021
After recruiting reliable employees, growing sales and building a great reputation, it's time to sell the business. Your success has attracted a qualified buyer. You focus on introducing your business to the buyer, expanding on synergies and providing financials, while the buyer (or, more likely, buyer's attorney) is asking you to provide legal and operational documents for review, a process called legal due diligence.
You can push back on the demands for more documents, but pushback can be problematic. It may raise a question in the buyer’s mind about transparency: Are they getting all information the information necessary for them to identify and quantify risks? Further, the buyer sees the transaction from their own perspective; they may see factors that you live with as part of the business as substantial risks that they need to take into account. And pushback can trigger a process of legal “post office”: the seller’s attorney consults the buyer’s associate who, perhaps after checking with his or her partner, confirms the response with the buyer before passing the response back through the same channels - and then requests more documents or information potentially leading to another cycle. The back and forth can be delay due diligence and (potentially) the closing, and result in more legal fees.
What is the alternative? An understanding of what due diligence is (and is not) can help.
While the buyer and seller focus on the business and finances, the attorneys are dealing with the legal mechanics. They confirm the completeness and accuracy of the seller’s information and documents, noting and filling in any gaps. They also look for legal risks to deal with in the purchase agreement (the asset or stock purchase agreement) or to be listed in the disclosure schedules to the purchase agreement. Buyer’s attorney looks for unwanted liabilities or assets to exclude from the sale, while seller’s attorney seeks to limit seller’s representations and warranties by revising wording in the purchase agreement or by disclosing exceptions to them in the disclosure schedules. Complete and detailed disclosure in those schedules is the seller's friend. As an example, the effect of the agreement and schedules together is to say, "yes, I will be responsible for outstanding warranty claims (through offset against any holdback or through civil suit), but not for the ones listed in the disclosure schedules; you take on that responsibility."
Both attorneys are motivated to be comprehensive, preferring to err on the side of asking too much during the due diligence exercise rather than too little. Buyer’s attorney is determined not to overlook hidden liabilities that may have to be dealt with after closing, and seller’s attorney is determined not to leave out a disclosure that could result in holding back part of the purchase price or a civil suit after the closing.
Given these goals, several strategies help reduce demands on the seller’s time during legal due diligence:
- Recognize that due diligence takes substantial time. Organize business files in advance; demands on seller’s time usually multiply as the date of sale approaches.
- Decide on the allocation of the legal due diligence work. Organizing and scanning original files can save time and costs, but seller's attorney's staff may be able to help if time is short.
- Organize documents according to the numbers of questions in the legal due diligence request list provided by buyer, and label digital documents so they can be identified without opening them.
- Answer “yes”, “no” or “not applicable” to due diligence questions, and then move on. Legal due diligence is an exercise to confirm information and identify disclosures. There is often a story behind why actions were taken but no reason to explain or justify them in the due diligence exercise.
- Scan all attachments, amendments, signature pages and related documents from the original files (such as separate license or non-disclosure agreements). Taking time to conduct a thorough first search minimizes time spent on second and third searches.
- Ask third parties for documents within their specialty. For example, the seller’s accounting staff or outside accountants can usually extract information from financial statements for exceptions to representations and warranties in the purchase agreement more efficiently than attorneys can. HR documents can be organized and presented efficiently by the seller's HR services provider.
- If a document cannot be found or reasonably replaced (e.g., by requesting a copy from a counterparty), notify seller’s attorney in writing at the time the related documents are uploaded to the data or document room. Buyer and seller, their attorneys, and members of their respective staffs may participate in legal due diligence. Without a written response as place holder, seller may be requested to provide the missing document multiple times over the course of legal due diligence.
If you are considering sale of your business and have questions about due diligence, please do not hesitate to contact Marson Law P.C.
By Allan Marson, Esq. Allan is principal and founder of Marson Law P.C.
