Major transactions, such as mergers and acquisitions, require a lot of work and meticulous attention to detail. One of the most crucial parts of these deals is the due diligence process. Due diligence ensures informed decision-making, risk mitigation, and protection of corporate interests.
Due diligence equips each party with a better understanding of the risks and opportunities in a transaction. Due diligence can uncover unknown or undisclosed information, so proper and thorough due diligence is important regardless of the transacting parties’ relationship, goodwill, or trust.
What is Due Diligence?
Due diligence is the process of reviewing the parties’ legal, financial, operational, and regulatory framework. This includes examining the target corporation’s Articles of Incorporation, Bylaws, policies, contracts, and other documents. Due diligence aims to uncover potential risks, liabilities, and opportunities associated with the transaction. Proper due diligence equips the parties with the information needed to make educated and commercially responsible decisions.
Due diligence dictates how the transaction will come to fruition. Each corporation’s Articles of Incorporation, Bylaws, and policies establish the framework for each transaction. For example, a corporation’s Articles of Incorporation may restrict the corporation’s powers to enter into certain transactions.
Indeed, a 501(c)(3)’s Articles of Incorporation must irrevocably dedicate its assets to charity. If those assets are being acquired, they must be acquired for use to further the corporation’s exempt purposes (even if the 501(c)(3) will cease to exist post-transaction). Bylaws set out the rules for authorizing the transaction, such as requiring member approval or a heightened super-majority Board approval for major transactions.
Moreover, contracts, mortgages, promissory notes, and other instruments often require third-party approval to be assigned or transferred. In some cases contracts cannot be assigned, so the parties will need to take additional steps to transfer certain assets or liabilities.
Due diligence uncovers each of these intricacies, and more, so that the transaction is legally effective and no matter is left unresolved.
Why is Due Diligence Important?
Due diligence protects the parties by identifying and evaluating potential risks and liabilities associated with the transaction. By uncovering these risks early in the process, the parties can develop strategies to manage or mitigate them, preventing unforeseen complications post-transaction.
Major transactions, such as the ones requiring due diligence, often touch all areas of the parties’ business. Due diligence ensures that the parties adhere to the various requirements in areas such as employment law, environmental regulations, intellectual property protection, contracts, and more. Failing to comply with certain requirements can lead to severe legal consequences, financial penalties, and reputational damage.
Due diligence is not only about identifying risks; it also plays a pivotal role in protecting the interests of stakeholders. By conducting a thorough examination of the parties’ business enterprise, the parties can be sure that there are no hidden issues negatively impacting the relevant stakeholders post-transaction.
Armed with the insights gained during the due diligence process, each party is better positioned to negotiate favorable terms and structure the deal in a way that maximizes value and minimizes risk. A clear understanding of the parties’ strengths and weaknesses allows for informed decision-making, thus facilitating a smooth transaction.
Due diligence is the foundation upon which successful transactions are built. It is not a formality or merely a box to check. Though due diligence is often one of the more costly and time-intensive stages in a transaction, its importance cannot be overstated. The time and expense spent on thorough due diligence avoids even costlier and more time-consuming litigation in the event something goes awry or is uncovered post-transaction. For these reasons, due diligence is paramount in protecting the parties’ interests and ensuring a successful transaction for all stakeholders.
Kyler Mejia is an attorney (bar pending) with Caritas Law Group, P.C. Kyler advises nonprofit and socially responsible businesses on corporate, trademark, tax, and fundraising regulations nationwide as well as donors concerning major gifts. To schedule a consultation, call 602-456-0071 or email us through our contact form.