Lawyer | Wu Jie: How to Conduct Legal Due Diligence in Enterprise Merger and Acquisition Transactions (1)

Legal due diligence is a very fundamental but extremely important aspect in corporate mergers and acquisitions. Under the current integrity system, any successful merger and acquisition transaction is based on and premise of high-quality due diligence. Conducting a merger or investment without or ignoring due diligence is like planting an untimely bomb around oneself at a high price.

Legal due diligence is a very fundamental but extremely important aspect in corporate mergers and acquisitions. Under the current integrity system, any successful merger and acquisition transaction is based on and premise of high-quality due diligence. Conducting a merger or investment without or ignoring due diligence is like planting an untimely bomb around oneself at a high price.


General steps for legal due diligence


The steps of legal due diligence generally include three stages: preliminary preparation, on-site due diligence, and report drafting and review.


1. Preliminary preparation


Everything is predetermined, but unprepared is abandoned, and due diligence is also the same. A successful and efficient due diligence cannot be achieved without sufficient preparation in the early stages. In the preliminary preparation stage, as the acquiring party and due diligence lawyer, at least the following preparations should be made:


(1) Determine the delegation and form a team. The premise of legal due diligence is that the lawyer and the client sign a commission agreement, and commission is the basis for the lawyer's work. Whether it is the acquiring party or the lawyer, forming a due diligence team for a certain project is the first step in preparation. At this stage, the main task of the due diligence team is to clarify the division of labor and prepare for the due diligence; The second is to communicate well and lay the foundation for the next step of work. In many cases, the smoothness of communication often has a significant impact on the conduct of due diligence and subsequent mergers and acquisitions or investments.


(2) Understand the needs and develop a plan. The project requirements proposed by the client determine the depth and breadth of legal due diligence, as well as the focus of due diligence. In real estate mergers and acquisitions, it is necessary to focus on the detailed information of the project plot and properties; In general corporate mergers and acquisitions, the historical evolution, equity situation, and debt obligations of the target company may often be the focus of due diligence. After determining the project requirements, as the acquiring party, a preliminary merger plan and plan need to be developed, while as a lawyer, a detailed due diligence work plan needs to be developed based on the acquiring party's needs and plans.


(3) Understand the object and conduct legal searches. In the early preparation stage, it is crucial to understand the subject of due diligence. As a acquiring party, it is necessary to understand the background information and industry information of the due diligence target, as well as the core information related to the project that the acquiring party is most concerned about. As a lawyer, based on understanding the subject, purpose, and scope of due diligence, it is necessary to conduct a comprehensive search and understanding of the industry, business laws and regulations, as well as local laws and regulations, according to specific project needs, and gradually organize the laws and regulations related to project transactions. This work, in addition to the preliminary preparation stage, needs to be continuously improved as due diligence progresses.


(4) Design a questionnaire and provide a checklist. In most cases, apart from the commission procedures and confidentiality agreements, the first document sent by the lawyer to the acquiring party is often the list of materials for this due diligence investigation. In terms of the entire due diligence, this first list is the "outline" of the entire due diligence. The due diligence list contains almost all the content of this due diligence and serves as the basis for the information provided by the target company. Whether this' outline 'is appropriate and meets transaction needs requires lawyers to design it based on project requirements and transaction purposes. It should be noted that in a large number of mergers and acquisitions projects, many lawyers use the due diligence checklist from previous projects as a template. There is nothing wrong with using templates, but two points must be noted: firstly, the design and development of templates should be targeted, at least targeting different industries or project needs, and developing different due diligence list templates tailored to different types of enterprises, in order to achieve the purpose of due diligence.


In addition, before sending the due diligence list to the target company, it is recommended that the lawyer communicate with the acquiring party on whether the due diligence list meets the transaction purpose or needs. At the same time, in the due diligence process, for any new situations or issues discovered, it is necessary to update the due diligence list in a timely manner, or create a supplementary list to provide to the acquiring party and the target company, to ensure the practicality and effectiveness of the due diligence list.


2. On site due diligence


On site due diligence is the core part of the entire due diligence process, and in this process, the on-site due diligence of the due diligence lawyer mainly starts from the following aspects:


(1) Data collection and organization. Similar to the collection and organization of evidence in litigation activities, the data collection and organization in this stage is based on the due diligence list, combined with the actual situation of the target company, comprehensively collecting and organizing relevant information and materials of the due diligence party through review of materials, on-site investigation, retrieval of files, interviews, and other methods, striving for the authenticity, accuracy, and completeness of the collected materials. It should be noted that in this stage of data collection, lawyers need to maintain the independence of the entire due diligence process and fulfill their "reasonable and prudent" obligations. Conduct work reasonably and prudently through on-site visits and interviews, investigations and consultations with relevant departments, and timely and effective communication with other professional institutions.


(2) Prepare working papers. After obtaining due diligence materials, lawyers need to prepare work papers in a timely manner. Work papers are the foundation and basis for lawyers to write due diligence reports and express legal opinions. At the same time, the quality of work papers is an important basis for measuring whether lawyers are diligent and responsible, and also an important guarantee for lawyers to prevent practice risks. For the data collected on site, we suggest organizing it according to the writing order of the due diligence report and compiling a directory list in the order of the data for later reference and verification. At the same time, we suggest organizing the materials provided by the target company, retrieved by relevant departments, and produced through on-site visits or interviews with lawyers into separate volumes. In principle, all materials provided by the target company need to be backed up in paper form and stamped with the target company's official seal or seal.


3. Report drafting and review


After the completion of on-site due diligence, the writing and review of the due diligence report is the top priority of the entire due diligence, and the due diligence report is the main carrier to showcase the achievements of the lawyer's work and an important reference to help the acquiring party make decisions. The work content of this section includes the following parts:


(1) Report drafting. The legal due diligence report generally includes three parts: preface, main text, and appendix. The preface mainly includes the purpose and scope of issuing the report, the abbreviation and definition of the report, assumptions, due diligence methods and limitations, the base date of the report, the disclaimer for issuing the report, and applicable laws. The main body mainly conducts a comprehensive legal analysis and explanation of the target company based on the information and materials obtained during the due diligence process, and provides legal evaluations or suggestions. We suggest adopting a legal fact+legal evaluation model for the writing logic of this section. The attachment section mainly lists the statistical tables that are inconvenient to insert directly in the main text, important information cited, and the list of documents and materials based on which the report is issued.


(2) Report and manuscript review. Whether litigation lawyers or non litigation lawyers, any documents issued to the public must undergo strict review. Review of reports, including review of text, review of legal issues, review of correspondence between report content and data, and review of overall work progress. At the same time, what should not be ignored at this stage is the review of the work papers. As the due diligence investigation approaches its end, a comprehensive and systematic review of the work papers compiled on site and corresponding due diligence reports is an important way to ensure the quality of work.


(3) Submission of results. The results of legal due diligence include not only due diligence reports, but also work papers, and many mergers and acquisitions require lawyers to submit due diligence reports and, if necessary, work papers. It should be noted that regardless of the type of document, it is necessary to ensure that the content is detailed and the viewpoints are objective and accurate. These documents represent the professional level and work attitude of lawyers, and cannot be overly refined.