We have encountered numerous instances recently whereby investors were about to make an investment without performing a prior legal due diligence examination. There are various reasons put forward by investors for not performing a due diligence examination, such as: the contemplated investment is in a young company, insufficient budget, cost-benefit considerations, the volume of the investment, timetables, long-standing work relations between the investors and the corporation, and the like.
As a rule, whenever we encountered a decision to not perform a legal due diligence before investing, the decision turned out to be wrong.
Undeniably, every investment involves some risk, but the degree of risk may be mitigated by performing a comprehensive examination of the business being acquired.
A legal due diligence process allows the investors to learn about the corporation in various aspects, including: the identities of the corporation's shareholders; its relations with the banking system; the approvals required from third parties; the corporation's pledged assets; the corporation's licenses and the potential impact of the transaction on their validity; its workforce and their employment terms, including exposures relating to the company's obligations to its employees, both by law and by virtue of the employment agreements with such employees; the corporation's tax exposures; the structure of the agreements with the corporation's suppliers, including the degree of risk involved in working with a few material suppliers; the corporation's customer base and the terms of engagement with them; the corporation's exposure to past lawsuits; necessary actions in order to protect the corporation's intellectual property rights, including the registration of patents, trademarks and copyrights; and the like.
The outcome of the due diligence examination should have a major impact on the nature of the contemplated transaction, inter alia: on the structure of the transaction (share purchase transaction or asset purchase transaction); on the transaction price; on the representations that will be required of the business being acquired and its owners, on the collateral to be provided to guarantee the investment; on the suspensive conditions to consummation of the transaction; indemnity clauses; the mechanism of the investment and, in the final analysis, on the very decision about whether or not to proceed with the transaction, considering the results of the due diligence examinations.
In this context, we further advise that in 2014 the Israel Antitrust Authority ("IAA") published a public statement addressing information disclosures between competitors during the performance of due diligence examinations prior to executing a transaction. According to the IAA statement, the importance of a due diligence examination to the efficient operation of a business on the one hand, and the concern about competition being compromised as a result of a due diligence being performed between competitors, on the other hand, obliges competitors that are conducting due diligence examinations of each other, to carefully and meticulously consider their actions. The main discussion in the IAA's foregoing statement targets the tension between the prohibition of becoming a party to an unlawful restrictive arrangement, and the need for an adequate factual foundation of knowledge for the purpose of forging a transaction between the competitors.
Originally published November 16, 2016
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
