Mergers and acquisitions (M&A) remain a key mechanism for companies to pursue growth by acquiring a target company’s business or shares, allowing them to expand into new markets, increase market share, and/or diversify their business.
M&A transactions often involve significant investments, and buyers will understandably want to investigate the target company or business to ensure they have a clear picture of the target’s assets, liabilities, risks, and commercial position before the transaction is completed.
This process of investigating the target company is known as due diligence (due diligence) and enables the buyer to make an informed decision on the transaction, appropriately allocate risk through the transaction documentation and, in certain cases, may influence the structure of the deal or result in a downwards adjustment to the purchase price, which is commonly referred to as a ‘price chip’.
Our Corporate Lawyers identify the essential legal strategies to navigate M&A transactions effectively, ensuring commercial objectives are achieved without exposing the parties to unnecessary risk.
Effective Planning and Deal Structuring
Early planning often proves the most valuable strategy for M&A transactions as it ensures that an appropriate deal structure and valuation mechanism are established.
Additionally, early planning also ensures that all parties are aligned with the same objectives and that any tax or regulatory considerations are addressed at an early stage. In practice, effective early planning often saves the parties both time and costs.
Choosing the appropriate deal structure
One of the first decisions is whether the transaction should proceed as a share purchase or an asset purchase. The appropriate deal structure will often depend on factors such as the nature of the Target business, any regulatory issues, risk appetite and/or any tax considerations.
In short, a share purchase involves the buyer acquiring the shares in the target company and, therefore, acquiring both the target company's assets and any pre-existing liabilities.
In contrast, an asset purchase involves the buyer acquiring only the company's business and assets.
This structure may allow the buyer to be selective as to the assets they choose to acquire, but often involves greater complexity, particularly around obtaining third-party consents for the assignment of contracts.
Exchange, Completion and Financing
In relation to exchange, completion and financing, early planning and deal structuring will involve a consideration of the following:
- Exchange and Completion arrangements: The parties will need to consider whether split or simultaneous exchange and completion is appropriate. Often, split exchange and completion is required where regulatory approval is required or where a business and asset purchase is used since the seller may require consent from third parties to assign certain contracts to the buyer.
- Financing arrangements: The buyer in an M&A transaction will also need to consider how they will finance the agreed purchase price. For example, debt-financed transactions will introduce the added complexity of the lender’s conditions within the transaction documentation and the likely requirement for security documentation.
- Valuation Mechanisms: The parties will need to agree whether to use a ‘locked-box’ valuation mechanism (which provides certainty as to the purchase price, subject to negotiations around the definition of ‘permitted leakage’) or whether a cash-free/debt-free mechanism (which allows for post-completion price adjustments using completion accounts) is used.
For sellers, early planning should also involve updating the companies’ records, such as statutory books and registers, whilst ensuring that key documents are readily accessible ahead of the due diligence process. Both of these actions help to reduce disruption and save time, and ultimately costs, during the M&A transaction.
What is M&A Due Diligence?
The seller is not required to disclose information to the buyer under the principle of ‘buyer beware’.
It is therefore incumbent on the buyer to conduct appropriate due diligence for the nature of the transaction.
Before commencing the due diligence process, the parties to an M&A transaction will typically agree on the scope of the due diligence.
Additionally, given the typical sensitivity of documents and other information disclosed during the due diligence process, the seller may insist that the parties enter into a confidentiality agreement before conducting the due diligence.
The scope of due diligence will typically depend on a number of factors, including the:
- Type and size of the M&A transaction;
- Sector in which the target business operates; and
- Buyer’s risk appetite.
In general, larger or more complex M&A transactions tend to justify more extensive due diligence as the consequences of unknown risks may be more significant.
Equally, if the target business operates in a regulated sector, such as financial services, the buyer will need to conduct enhanced due diligence on regulatory approvals and ongoing regulatory compliance obligations.
Key Areas of Due Diligence
Although the precise scope of due diligence will depend on the nature of the deal and the factors set out above, in respect of legal due diligence, M&A transactions typically include the following key areas of due diligence:
Corporate Due Diligence
Corporate due diligence aims to examine constitutional documents, share capital arrangements and any ownership issues, applicable option agreements, the group structure, and any intra-group arrangements.
Commercial Due Diligence
Commercial due diligence includes reviewing key customer and supplier contracts. In particular, it will be key to identify any change-of-control clauses that may be triggered by the proposed transaction and that may allow the contracting counterparty to terminate or renegotiate contractual arrangements.
Employment Due Diligence
Employment due diligence typically covers employment contracts and policies, potential implications under TUPE (if the deal is structured as a business and asset sale rather than a share sale), key personnel, incentive schemes, and pension arrangements.
Property Due Diligence
Where the target owns or occupies property, property due diligence will involve a review of title to the property, reports on any leases, including any break clauses, dilapidations liability, and compliance with other conditions, such as planning requirements.
Intellectual Property (IP) Due Diligence
Where IP is a key asset of the company, IP due diligence will investigate ownership of any IP, any licensing arrangements and any IP infringement claims, such as trademark disputes.
Regulatory Due Diligence
Regulatory due diligence includes an assessment of any required regulatory compliance steps, both upon completion of the transaction and for ongoing regulatory compliance.
In addition to legal due diligence, potential buyers may also wish to conduct financial and tax due diligence. In summary, due diligence can and often does cover various areas that will require input from specialist legal, financial, and tax advisors.
Due Diligence Questionnaire and Virtual Data Rooms
The due diligence questionnaire is a comprehensive document submitted by the buyer’s solicitors to the seller’s solicitors, which sets out a list of questions designed to uncover key information about the target company.
The questionnaire should be appropriately tailored to the specific transaction, sector and risk profile of the target business to provide a complete picture.
In response to the due diligence questionnaire, the seller’s solicitors will provide responses and give the buyer access to the relevant documents, often stored in a Virtual Data Room (VDR), allowing the buyer’s financial and legal advisors to review the information securely.
For sellers within an M&A transaction, providing accurate and comprehensive responses to due diligence enquiries in a timely manner during the due diligence stage is essential to encourage the smooth and timely progression of the transaction and can provide the buyer with greater confidence.
Due Diligence Reporting and Post-Due Diligence Steps
Following a review of the information provided within the VDR and the seller’s solicitors' responses to the Due Diligence Questionnaire, the buyer’s solicitors will often produce a ‘red flag report’.
This details the identified risks and categorises them as low, medium, or high.
In cases where more comprehensive due diligence has been required, the buyer’s solicitors may instead provide a more extensive due diligence report, which is initially produced in draft form and then finalised into a final due diligence report.
Following the initial review of documents within the VDR, post-due diligence steps could include:
- Raising further enquiries with the seller’s solicitors, for example, where the responses provided to the due diligence questionnaire are insufficient or unclear; and/or
- Negotiating amendments to the transaction documents, for example, the buyer may want to negotiate specific indemnities to provide additional protection; and/or
- In certain cases where issues identified during the due diligence process are significant, this may warrant a reduction in the overall purchase price (the ‘price chip’), which would need to be negotiated between the parties.
Carrying out targeted due diligence, which is tailored to the seller’s business and to the sector in which the seller operates, allows the buyer to accurately assess risk which can subsequently be allocated through negotiations to the transaction documents.
Negotiating the Transaction Documents
Beyond the purchase price, as part of the asset purchase agreement (APA) or share purchase agreement (SPA), as applicable, there will likely be several areas for negotiation between the parties. Key areas for negotiation often include:
Definitions and Valuation Mechanics
For example, if a ‘locked box’ valuation mechanism is being used, the definition of “Permitted Leakage” will often be negotiated to ensure that the seller cannot unreasonably extract value from the company between the date of the locked box accounts and the date of completion.
Deferred Consideration and Earn-Out Provisions
In respect of deferred consideration, the parties will need to balance the seller’s likely demands for sufficient consideration upfront with the buyer’s cash-flow concerns and negotiate according to these priorities. The inclusion of earn-outs help to bridge valuation gaps between the parties as they provide for additional payments if the company reaches specified financial targets following completion. Naturally, the parties will want to negotiate both the details of such financial targets and the resulting additional payments.
Warranties and Indemnities
Warranties and Indemnities, including potential caps on liabilities for indemnities, will often be key areas for negotiation between the buyer and the seller. It is also important to note that Warranty & Indemnity (W&I) insurance may need to be considered to mitigate the risk of breaches of warranties claims or claims under indemnities.
Restrictive Covenants
These provisions within the APA or SPA (as applicable) can include non-compete and non-solicitation clauses to prevent the seller from establishing a competing business or poaching clients of the Target business, respectively. The buyer may equally want to negotiate the inclusion of a ‘non-poaching’ restrictive covenant clause to prevent the seller from enticing certain employees to join a new, competing business.
It is crucial that the parties to an M&A transaction are mindful of which provisions they are willing to negotiate and that they adopt a clear strategy in relation to risk appetite and the negotiation of key transaction documents.
Communication and Project Management
Consistent and proactive communication both between the parties and between advisers throughout the M&A transaction is essential for the efficient progression of the deal and to ensure that all parties remain aligned on key issues, risks and priorities.
Effective communication includes:
- maintaining regular check-ins with legal, tax and financial advisers;
- ensuring that specialist advisers, such as commercial, employment, intellectual property and commercial property legal advisers are aligned on transaction-specific issues;
- co-ordinating between parties in different jurisdictions, including both overseas legal and tax advice; and
- escalating any issues at an early stage to avoid delays or last-minute crises.
Contact Our Corporate Team
Our Corporate lawyers have extensive experience advising buyers and sellers on all aspects of due diligence, from identifying key risks to negotiating appropriate protections within transaction documents.
If you are considering an acquisition or disposal and would like expert guidance on the due diligence process, please get in touch with our Corporate team to discuss how we can support you.
0161 941 4000
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James Banks
Trainee Solicitor
James joined as a Trainee Solicitor at Myerson in 2024. Prior to joining the firm, James graduated from Durham University with a First Class Honours LLB. He is currently completing the SQE qualification with BPP University in Manchester.
About James Banks