Frequently, the contact with lawyers, accountants, tax advisers conducting a due diligence, also known as audit or DD, is the first contact with professional consultants in those areas. This may lead to unnecessary misunderstandings. What is such process and how can you survive it? We invite you to read the article in which we discuss the basics of the legal due diligence.
What is due diligence?
Due diligence is a comprehensive examination of an entrepreneur’s situation in which a team of auditors composed of branch-specific specialists analyze the entrepreneur’s condition in financial, commercial, tax, technological and legal terms.
We can provide you with most extensive information on the last area, that is legal due diligence, since we carry out legal audits of companies on an ongoing basis on behalf of the parties interested in investing in such companies, who want to make sure if the investment is not going to be too much of a risk. Therefore, in purely general terms, due diligence is about making sure if the investor – entering the company – is not going to step on a “mine”.
Legal due diligence
To put it short, legal DD is an analysis of:
- an entrepreneur’s legal situation in terms of most probable legal risks,
- their division into categories,
- formulation of conclusions,
- preparation of a timetable for the removal of faults.
What if due diligence reveals irregularities
Sometimes, though relatively rarely, conclusions following an examination lead to withdrawal from the prospective investment by parties unwilling to bear the risk if the DD report shows that its materialization is too probable and the risk cannot be mitigated as a part of the conducted activities.
Vendors due diligence or trial audit
The first step which may contribute to a mild course of a DD is a prior internal audit in terms of any potential shortcomings and threats, and their elimination to the fullest possible extent. Such preliminary check is also a good training for the entire team – it prepares the team to face what can be expected.
Obviously, an internal preliminary audit (also referred to as VDD – vendor’s due diligence) is not a necessity and most start-ups do not decide to take such step, mostly because of additional and quite considerable costs of such examination. As opposed to the internal process, the costs of examination of a company by an external consultant, when ordered by an investor, are usually borne by such investor.
Due diligence – checklist
As the representative of the audited company, you will receive a list of questions drawn up by auditors. The list will cover different aspects of your company’s activities, in particular:
- corporate matters,
- agreements with contractors,
- financial matters,
- matters of intellectual property protection,
- personal data protection,
- staff-related matters,
- questions about court proceedings or administrative checks.
On the basis of such list, information and documents will have to be gathered. These days, they are most often collected in a virtual data room (VDR). You must reckon the fact that auditors have the right, or even obligation dictated by the need to exercise due professional care, to ask you about everything that raises their doubts in the investigated area, or to ask for additional documents.
Be prepared that every decision and action taken will be scrutinized. This may provoke an opposing or even angry reaction in persons who experience such process for the first time. However, you must remember about the main goal: to give the investor a sense of security, and allow your company to obtain the necessary funding.
How to go through due diligence without problems
If due diligence is still ahead of you, take a deep breath, count to ten and read the following pieces of advice, which can make your life simpler during the DD:
1. Read calmly and carefully the list of questions from auditors
It usually contains short instructions on how to gather documents, name files, split them between folders, and how many documents should be made available. This is of much help to the auditor and take our word that you do not wish the auditor to be ill-disposed to you.
2. Hold a teleconference with auditors
Tell them about your business, help them understand its essence; the understanding of your business will make it easier for the auditor to assess what is valid for the DD and what to focus on.
3. Make a list of all documents which, in your opinion, should be included in each of the indicated sections
This may be helpful in your search for such documents and their uploading to the VDR.
4. Collect all documents as soon as possible
Do not add consecutive scans to the VDR at severalday intervals. Remember that not only the auditor but also you want the DD to proceed quickly and smoothly because completion of the DD is a precondition to the conclusion of the investment agreement.
5. Share complete documents only
If they ask you for a scan of an agreement, they mean the entirety, that is the agreement with all addenda that have ever been concluded. Remember about the attachments! Even if its tedious and time-consuming, remember that in effect that will save tie of both sides.
6. Do not be overeager
The auditors ask you for 5 examples of documents? Do not send 30 – this will save the auditors the additional work related to selection and analysis of documents.
7. Ask and talk
You do not have to know everything, especially if this is your first due diligence, and the auditor does not have to know that there are some unclear matters for you.
8. Explain doubts on an ongoing basis
It is better to remove doubts in a conversation or to provide the auditor with additional documents than to have the doubts reflected in the report.
9. Remember that the auditors are not your enemy
They are professionals, probably with much experience, and the results of the auditors’ work may be very helpful to your company.
10. Cooperate with a smile 😊
Magdalena Pająk – attorney-at-law. Graduate of the Faculty of Law and Administration of the University of Warsaw, specializing in contract law, commercial law and personal data protection law. She is especially interested in the law of the Internet and new technologies, successfully combining that interest with the knowledge of intellectual property law, especially rights relating to computer software and possibilities of using such knowledge in software commercialization.
She leads a team handling construction investment from the legal perspective, under her supervision highly specialized industrial investments have been implemented of a value over 750 million PLN. She manages a team of auditors conducting pre-investment due diligence for private equity and venture capital investment funds, among others, for Pracuj Ventures, Market One Capital and Experior Venture Fund. She participates in investment processes, taking care of our Clients’ investment security.
Besides, she strives to ensure that the Law Firm deserves to be called a “green” law firm.