What Legal Due Diligence Is Required When Buying a Business?

Buying an established business can be an exciting opportunity. You might not be building a new customer base, team, contracts, premises, IP and history of trading, but you may be buying it all. However, appearances are deceptive and it is not always what is seen on the surface. A business might appear to be profitable and well-managed, but have contractual commitments, employment issues, legal risks associated with property, or other legal issues that may not become apparent until after a transaction is finalized. That is why legal due diligence during the due diligence process is important during a business acquisition. The rationale behind the concept of doing the work before you buy is that it will enable the buyer to better understand the legal situation prior to the acquisition. Not just a matter of thinking of ways not to go through with it. It is often to gain proper understanding of the risks and to negotiate appropriate protection and make an informed decision about the transaction. KLG Law’s commercial and corporate team advises businesses on transactional matters including acquisitions, alongside commercial contracts and other business arrangements. You can find out more about KLG Law’s commercial and corporate legal support here. What is legal due diligence when buying a business? The process of conducting a legal review of the company’s affairs before the acquisition is finalized. The Buyer’s Solicitor will generally seek information and documents from the Seller and consider whether there are any legal matters which might impact on the transaction and/or the value of the business or the Buyer’s position post-completion. No one-size-fits-all legal due diligence checklist exists. The checks must be commensurate to the transaction. A small firm of three people, no premises, no valuable intellectual property, no long term contracts with customers, and no pending litigation may have a much more limited review than a firm of 100 people, whose premises and valuable intellectual property are leased, who have long-term customer contracts, and who are involved in ongoing litigation. HMRC describes due diligence generally as a process of identifying and managing risk before entering into a business relationship or transaction, with the extent of the checks depending on the risks involved. Share purchase or asset purchase matters One of the first legal questions is whether you are buying the shares in the company or buying selected business assets. The distinction can have a major impact on due diligence. In a share purchase, the buyer acquires the company itself. The company’s existing rights and liabilities generally remain with the company after the sale. That means the buyer needs to investigate the company carefully, including historic liabilities that may not be immediately obvious. An asset purchase is different. The parties identify which assets and, depending on the transaction, which liabilities are being transferred. This does not mean an asset purchase is automatically simpler. There can still be significant legal work around contracts, employees, intellectual property, property, licences and other assets. The acquisition structure should therefore be considered at the beginning, not after the due diligence has already started. What should be included in a legal due diligence checklist?  The exact checks will depend on the business, but a buyer’s legal due diligence will commonly cover the following areas. 1. Company structure and ownership The buyer should establish exactly who owns the business and whether the seller has the authority to sell it. For a company acquisition, this can involve checking matters such as: The company’s registered details Share ownership Articles of association Shareholder agreements Existing charges or security Directors and corporate structure Previous share transfers Options or rights affecting shares This is particularly important where there is more than one shareholder. You do not want to discover shortly before completion that another person has rights over the shares or that the proposed seller cannot transfer them in the way originally expected. 2. Existing commercial contracts Contracts are often one of the most valuable parts of an established business. A company may rely heavily on a small number of customers, suppliers, distributors or strategic partners. The buyer therefore needs to know what those agreements actually say. The solicitor may review: Customer contracts Supplier agreements Distribution arrangements Agency agreements Franchise agreements Outsourcing arrangements Service agreements Software licences Maintenance contracts Confidentiality agreements Loan and finance documents Particular attention should be paid to clauses dealing with termination, assignment, change of control, exclusivity, liability and minimum commitments. A contract that can be terminated simply because the company changes ownership could be commercially significant. A practical legal due diligence checklist when buying a business Before committing to an acquisition, a buyer should consider whether the following areas have been properly investigated: Corporate structure Who owns the business? Who has authority to sell it? Are there shareholder agreements? Are there charges or other security interests? Are there restrictions affecting the shares? Contracts Which customer and supplier contracts are commercially important? Can they be assigned? Do they contain change of control provisions? Can the other party terminate following the acquisition? Are there unusual liabilities or guarantees? Employees Who works for the business? What are their contractual terms? Are there disputes or grievances? Are there restrictive covenants? Could TUPE apply? Property Does the business own or lease its premises? What are the lease terms? Is landlord consent required? Are there repair or dilapidation liabilities? Intellectual property Who owns the brand? Are trademarks registered? Who owns the website and software? Have contractors assigned intellectual property rights? Data protection What personal data does the business hold? How is it used? Are privacy notices and processing arrangements appropriate? Have there been data breaches? KLG Law’s commercial contract solicitors advise businesses on drafting, reviewing and negotiating commercial agreements, including supply, distribution, outsourcing, agency and franchise arrangements. 3. Employment contracts and employee liabilities Employees can represent a significant part of the value of a business, but they can also create legal liabilities that a buyer needs to understand. The due diligence process may include reviewing: Employment contracts Pay and benefits Bonus arrangements Pension obligations Holiday entitlement Restrictive covenants Disciplinary and grievance matters Ongoing employment disputes Settlement agreements Redundancy issues Family leave Employment Tribunal claims Where the transaction involves a business or undertaking transferring from one employer to another, TUPE may apply. TUPE can protect employees when a business or part of a business transfers to a new employer. There are also information and consultation obligations and specific rules concerning changes to employees’ terms and conditions. KLG Law also provides employment contracts and HR legal advice for businesses, which can be particularly relevant where an acquisition involves a substantial workforce. 4. Property and premises If the business operates from commercial premises, the buyer needs to establish what rights the business has over those premises. If the property is leased, the solicitor should review the lease and related documents. Issues can include: Length of the lease Rent and service charges Break clauses Repair obligations Assignment provisions Restrictions on use Rent reviews Guarantees Dilapidations Landlord consent The buyer should also establish whether the premises are actually required for the business to continue operating. A business may appear attractive until the buyer discovers that its premises lease expires shortly after completion or that the landlord’s consent is required before the transaction can proceed. If property forms a significant part of the acquisition, specialist property advice may need to sit alongside the wider transaction work. 5. Intellectual property For some businesses, intellectual property is one of the most important assets being acquired. This can include: Trademarks Copyright Registered designs Patents Domain names Software Databases Branding Business content Trade secrets Know-how The buyer should establish who actually owns the relevant intellectual property. This sounds obvious, but ownership is not always straightforward. For example, a company may use software developed by a contractor. If the contractual arrangements did not properly transfer the relevant intellectual property rights, the company may not own everything it assumes it does. The same issue can arise with branding, website content, photography, written material and other creative work. Where intellectual property is central to the acquisition, it should receive considerably more attention than simply checking whether a trademark exists. 6. Data protection and customer information If the business holds customer, employee or other personal data, the buyer should consider the legal arrangements surrounding that information This may include reviewing: Privacy notices Data protection policies Data processing arrangements Customer databases Data retention practices Data breaches Subject access requests Contracts with processors International data transfers where relevant The acquisition itself can also raise questions about how personal data is transferred and used. The buyer should not assume that because the seller has been holding personal information for years, the buyer can automatically use it in whatever way it wants after completion. KLG Law’s wider legal support for businesses includes advice around GDPR and data protection compliance, alongside employment and commercial matters. 7. Regulatory licences and permissions Some businesses cannot operate lawfully without particular licences, registrations or regulatory approvals. Examples might include businesses operating in regulated areas such as healthcare, financial services, transport, education, food or certain professional sectors. The buyer should establish: Which licences the business holds Who holds them Whether they can be transferred Whether a change of ownership requires notification Whether regulatory consent is required Whether there have been previous regulatory breaches Whether any investigations are ongoing A business acquisition can become considerably more complicated if the buyer assumes a licence automatically follows the business when it does not. 8. Litigation and disputes A buyer should find out whether the business is involved in any current or threatened disputes. This includes more than cases already issued in court. The due diligence process should consider potential disputes involving: Customers Suppliers Employees Former employees Landlords Contractors Competitors Regulators A dispute that has not yet reached court can still create a substantial liability. The buyer should also ask whether there have been previous claims or complaints that could potentially develop into legal proceedings after completion. If an acquisition uncovers an existing commercial dispute, KLG Law’s dispute resolution solicitors can advise on contractual and commercial disputes and potential strategies for resolving them. What happens if due diligence finds a legal problem? Finding a legal problem does not necessarily mean the acquisition has to be abandoned. In many cases, the discovery simply gives the buyer information that can be used during negotiations. Depending on the issue, the buyer might: Ask the seller to resolve the problem before completion Renegotiate the purchase price Request a specific indemnity Seek additional warranties Require a contractual undertaking Exclude an asset or liability from the transaction Make completion conditional on a particular event Decide that the risk is unacceptable and withdraw The appropriate response depends heavily on the nature and seriousness of the issue. This is one of the reasons it is important to conduct due diligence early enough for the findings to influence the transaction. There is little value in discovering a serious contractual problem after the purchase price and transaction documents have effectively been settled. What are warranties and indemnities? Warranties and indemnities are important parts of many business acquisition agreements. A warranty is essentially a contractual statement about the business or a particular fact. If a warranty is untrue and the buyer suffers a qualifying loss, the buyer may have a contractual claim, subject to the terms of the agreement. An indemnity is generally designed to provide compensation for a specified liability or loss. The two should not be treated as interchangeable. A buyer’s solicitor will consider the due diligence findings when negotiating the warranties and indemnities required in the acquisition agreement. This is where the legal due diligence process connects directly with the transaction documentation. Should you use a solicitor when buying a business? For a significant business acquisition, specialist legal advice can be extremely valuable. Buying a business is not simply a matter of agreeing a price and signing a sale contract. The transaction may involve company law, contract law, employment law, property, intellectual property, data protection and regulatory requirements. The solicitor’s role is not just to read documents. A good acquisition solicitor should help you understand what you are buying, identify legal risks, negotiate protections and make sure the transaction documents reflect the commercial deal. KLG Law’s commercial and corporate team includes solicitors advising on transactional matters including acquisitions and joint ventures. How much legal due diligence is enough? There is no useful answer in terms of a fixed number of documents or hours. The right level of due diligence depends on the transaction. A buyer acquiring a small local business may not need the same investigation as someone purchasing a company with significant intellectual property, dozens of employees, multiple properties and millions of pounds of contractual commitments. The important thing is that the investigation is proportionate to the risk. A buyer should also avoid treating the seller’s answers as the end of the process. Information should be checked against supporting documents where appropriate. If something does not make sense, ask about it. If a contract appears to have expired, investigate it. If the seller says there are no disputes but correspondence suggests otherwise, that needs to be resolved before completion. Due diligence is most useful when it is genuinely investigative rather than a box-ticking exercise. When should legal due diligence begin? Ideally, legal due diligence should begin well before completion. The precise timing will depend on the transaction, but buyers should not leave it until the last few days before signing. The earlier a legal problem is identified, the more options the buyer usually has. You may be able to negotiate a price adjustment, obtain an indemnity, require the seller to fix the problem or reconsider the transaction. Leaving the investigation until the end can create unnecessary pressure. Worse, the buyer may feel committed to a deal before discovering an issue that should have influenced the original negotiations. What should you ask a solicitor before instructing them? If you are looking for a solicitor for buying a business, it is worth asking whether they regularly handle acquisitions and what parts of the transaction they will cover. You may want to establish: Whether they advise on both asset and share purchases Their experience with businesses of a similar size What their due diligence will cover Whether they will negotiate the acquisition agreement Whether employment and TUPE issues can be handled as part of the transaction How they charge Who will actually handle the matter What information they need from you Cost matters, but so does having the right scope of work. KLG Law can provide independent legal advice on commercial contracts and other significant legal documents, helping business owners understand their contractual obligations before signing. Buying a business? Get legal advice before you commit Buying an established business can be a major financial and commercial decision. The legal documents may represent only one part of the transaction, but they can determine what liabilities you take on and what protection you have if something goes wrong. Proper legal due diligence gives you the opportunity to understand the business before completion and negotiate where necessary. If you are considering buying a company or acquiring an existing business, KLG Law can advise on the legal checks, transaction structure, contracts and wider legal risks involved. Speak to KLG Law about your business acquisition and get practical legal advice before you commit to the transaction. Final Thoughts Buying a business is a significant commitment, and the headline purchase price is only part of the equation. The real question is what sits behind that price. A proper legal due diligence exercise can uncover contractual obligations, employment liabilities, property restrictions, intellectual property issues, disputes and other risks before you become responsible for them. It also gives you something equally important: information. You can use that information to negotiate better protection, reconsider the transaction structure or decide whether the deal still makes commercial sense. If you are planning an acquisition, getting the right buying a business legal advice before signing the final documents can be one of the most sensible steps you take