M&A Due Diligence: What to Expect

The legal framework

Due diligence is the buyer's investigation of a target before it commits. M&A law is largely national: share and asset sales are governed by the contract law of the country whose law applies, and the target's company law governs its shares and decisions. The EU adds layers around the deal, such as merger control, data protection and the rules on employees in a transfer of a business. Many civil-law systems require good faith in negotiations and do not allow a seller to mislead the buyer, but how far that goes differs per country. The allocation of risk for what is discovered later is dealt with mainly in the contract. A buyer who could have found a defect through reasonable investigation will also have difficulty arguing that it was misled. For that reason diligence, warranties and price are closely connected: what the buyer finds is priced, covered by an indemnity, made a condition, or leads the buyer to walk away.

The reviews are usually organised by area. Corporate: the articles of association, share register, resolutions, cap table, and any restrictions on transfer. Contracts: key customer, supplier, licence and financing agreements, with attention to change-of-control, assignment, exclusivity and termination clauses. Employment: contracts, incentive plans, collective agreements and, in an asset deal, the transfer of employees. The EU Acquired Rights Directive (2001/23/EC) protects employees in a transfer of a business, and each country implements it in its own national law. Regulatory and compliance: permits, data protection (the GDPR applies EU-wide), and sector rules. Litigation: pending and threatened claims. IP and data: covered in more detail in IP in Due Diligence. Financial and tax diligence is usually run by accountants and tax advisers in parallel.

How the process runs

The process normally follows a fixed path. The parties sign a confidentiality agreement. The seller opens a data room with an index. The buyer sends a request list and later asks questions in waves. The legal team reviews documents, flags issues and, at the end, issues a report, often with a red-flag summary. The report is discussed with the client, who decides what to negotiate.

A well-run process has a single coordination point on the seller's side. Answers given by different people in different words are a source of later disputes, because buyers will rely on them, and sellers should expect that an answer in diligence can be treated as a statement of fact when the warranties are drafted.

From findings to contract

Findings take one of four routes. They are corrected before signing, for example by obtaining a missing assignment. They are reflected in the price. They are covered by a specific indemnity, because the risk is known but its size is not. Or they become a condition to closing, such as a third-party consent. Everything else the seller discloses against the warranties in the disclosure schedules, which limits claims for what was disclosed.

In practice

An industrial software company is sold by its founders to a Dutch group in a share deal. The buyer's lawyers find five points. First, a key customer contract lets the customer terminate on a change of control. Second, two contractors who wrote parts of the code never signed an assignment. Third, the register shows that the main trademark is registered in the founder's name and not the company's. Fourth, the data protection records are incomplete. Fifth, an employee incentive plan promises a payment on a sale that was not accounted for.

The parties handle them differently. The customer consent becomes a condition to closing. The assignments are signed before signing, in return for a modest payment. The trademark is assigned to the company. The records are completed after closing, with a covenant. The incentive payment is deducted from the price. The disclosure schedules then list what remains.

The seller could have avoided most of this by running a vendor review earlier, and by keeping a clean register of its IP. In our work, the data room is where such a process is organised, clause-level contract review is used to read the contracts against a playbook, and the portfolio platform gives an up-to-date list of registered rights.

Frequently asked questions

Who prepares the data room?

The seller, usually with its lawyers. A complete, indexed data room signals a well-run business and shortens the process.

What is a red-flag report?

A short report of the issues that could affect price, the deal structure or the decision to proceed, written before the full report is complete.

Does a seller have to disclose everything?

In many countries a seller must negotiate in good faith and may not mislead the buyer. Beyond that, the extent of disclosure is mostly a matter for the contract: anything properly disclosed against the warranties cannot later found a warranty claim. Sellers should answer accurately and consistently.

How long does due diligence take?

It depends on the size of the target and the quality of the documentation. Poor records take longer, and delays often arise from missing documents and late answers.

How this connects

Our M&A and due diligence service covers the review, the negotiation and the closing. For the deal as a whole, read M&A for Growing Businesses, and for the post-closing arrangements Transitional Services Agreements.