Mergers & Acquisitions – Due Diligence in M&A
The third and final part of the M&A article series will describe the practice of legal due diligence in M&A.
Private M&A transaction
Due diligence is a widely accepted practice in virtually all M&A deals of note in Finland. In a typical private M&A transaction, where there is only one purchaser candidate, the due diligence process is often driven by the purchaser. In such case, the process is normally initiated by the purchaser submitting a due diligence request list to the seller, specifying the information that the purchaser requests to be disclosed.
An auction process with several purchaser candidates, on the other hand, is generally coordinated by the seller or its advisor(s). The seller and its advisors typically arrange a data room for controlling the scope and quantity of the information that is disclosed to the purchaser candidates. Typically, the depth of information increases along the process as the number of purchaser candidates involved decreases. If the target company is publicly listed, the purchaser should also be aware of the insider rules and regulations and their implications on the contemplated transaction when conducting due diligence (see more below). Also specific vendor due diligences arranged by the seller are often carried out prior to allowing a potential purchaser to access information on the company and its business.
Due Diligence Investigation
Even though there are no precise standards for the scope of a legal due diligence investigation, certain market practices have developed over time. The areas covered may, however, vary depending on the industry and type of business in question. Further, the following issues may impact the scope of the due diligence: the purchaser’s expertise in the relevant business, the structure of the acquisition, the likelihood of unknown liabilities, the characteristics of the target, the relationship between the parties, the difficulty of conducting due diligence, the time, funds and resources available for due diligence, as well as the content and scope of the representations and warranties given by the seller.
A legal due diligence normally covers the following areas:
- Corporate structure and company organization (including basic corporate information, and ownership structure as well as historical share transfers in the case of a share deal);
- Corporate governance (including minutes of the board of directors’ meetings and general meetings of shareholders, corporate guidelines, operating licenses and other compliance documents);
- Properties (including title to real estate and lease agreements of premises);
- Liabilities (including loan agreements and other financing arrangements, inter-company indebtedness, pledges and other encumbrances, guarantees and other undertakings);
- Details of inter-company relationships;
- Material agreements (including acquisitions or disposals of assets or shares, supply, purchase, sale, maintenance, service, consultancy, distributor, agency, dealer, lease, license, cooperation, joint venture and similar agreements but also the identities of the largest customers, ongoing projects, and product warranties). The level of materiality is defined in the information request list sent to the seller prior to due diligence. Special attention is paid to third party transfer restrictions and change of control provisions;
- Management and personnel of the company (including management and employment contracts as well as pension and incentive schemes);
- Claims and ongoing litigation (including also possible tax claims); and
- Intellectual property, data protection, IT, insurances and environmental matters.
Due diligence is usually conducted concurrently with ongoing business negotiations and prior to the signing of a binding acquisition agreement. Prior to commencing the due diligence, it is common market practice for the seller and the potential purchaser to enter into a confidentiality agreement. As part of the due diligence, the seller usually provides the potential purchaser with the possibility to visit a data room with documentary information and to attend a management presentation and/or a site visit. Virtual data rooms and other data platforms form the standard for information sharing and have made physical data rooms obsolete. The material findings of the due diligence are presented and addressed in the final negotiations and, where necessary, reflected also in the final acquisition agreement.
Due Diligence Report
It is fairly customary to make due diligence reports available to third parties. Depending on the client, the type and nature of the transaction and the assignment of the lawyer, a due diligence report is often made available to certain third parties such as lenders or financial advisors (investment banks) of the client and the counterparty.
Obligations of the Sale of Goods Act
The basis for the disclosure and investigation obligations of the seller and the potential purchaser derives from the Sale of Goods Act as well as from the general contractual principles and practices of Finnish law. The Sale of Goods Act has been widely interpreted to apply to all types of share and business acquisitions. However, the provisions of the Act are discretionary in nature and therefore it is predominantly agreed in the final purchase agreement that the provisions of the Act are excluded and that only the terms of the final acquisition agreement shall apply.
The Sale of Goods Act imposes a duty on the purchaser to examine, upon the seller’s request, the goods prior to purchase. According to the provisions of the Sale of Goods Act, the purchaser may not invoke a fact that should have been noticed upon examination of the goods prior to the purchase. Even if the applicability of the Sale of Goods Act is nearly always excluded in the final purchase agreement, the general contractual principles of Finnish law support and verify this interpretation.
Due Diligence with Listed Companies
When conducting due diligence of a publicly listed company, the purchaser should be aware of the insider rules and regulations and their implications on the contemplated transaction. In the due diligence, the purchaser may receive information regarding the company or its securities that is not public and that may have a material effect on the value of the company’s securities (inside information). The purchaser may thereby become an insider and be prevented from trading in the shares of the target until the relevant information has been published. The Finnish Financial Supervisory Authority (FFSA) has, however, taken the view that transfers and acquisitions of certain large shareholdings would normally fall outside the scope of the insider information prohibition, provided that both the seller and the purchaser have equal knowledge of the company’s affairs. In an acquisition of all the shares in a publicly traded company through a public tender offer, any inside information received by the purchaser will need to be disclosed also to the public in connection with the tender offer, or otherwise the purchaser will be prevented from making the offer. It is, however, possible to conduct due diligence also on publicly traded Finnish companies, naturally provided that this is in the interest of the company and its shareholder collective and that the board of the target company agrees to it.
Read more on related topic from part I: Choosing the Structure: Private Share Purchases and Business Acquisitions of this article series.
Read more on related topic from part II: Choosing the Structure: Mergers, Joint Ventures, Licensing Agreements and Public Tender Offers of this article series.