"The numbers look good. But what is the business not telling you?"

The proposal appeared commercially attractive.

The company had reported consistent revenue, an established customer base and several valuable contracts. Its presentation showed strong growth, while management assured the investor that the business had no significant legal issues.

On paper, everything looked ready.

Shortly before signing, the investor appointed lawyers to conduct legal due diligence.

The review revealed that one of the company’s largest customers could terminate its contract if ownership changed. A substantial part of the business operated from premises without a properly renewed tenancy. Its principal trademark was registered in the founder’s personal name, and several payments described as “business expenses” were made to related parties without written agreements.

None of these issues appeared clearly in the financial presentation.

They did not necessarily mean that the transaction had to be abandoned. They did, however, change how the transaction should be valued, structured and documented.

That is the purpose of legal due diligence.

1. Legal due diligence is not simply a company search

A company search is usually an important starting point. It may provide information concerning the company’s incorporation, registered address, directors, shareholders and registered charges.

However, it does not provide a complete picture of how the business operates.

Many legal risks can only be identified by reviewing the company’s internal records, contracts, licences, correspondence and actual business arrangements.

A company may appear active and properly registered while still facing:-

• disputes that have not yet reached court;

• contracts that have expired or were never signed;

• restrictions on transferring shares;

• regulatory non-compliance;

• ownership disputes involving important assets;

• employee claims;

• obligations under personal guarantees;

• informal arrangements with related parties; or

• liabilities arising from previous business practices.

Public searches are therefore part of the exercise - not the entire exercise.

2. Why does the company’s history matter?

Under the Companies Act 2016, a company is a legal entity separate from its shareholders and directors. It may own assets, enter into contracts, incur liabilities and commence or face legal proceedings in its own name.

When an investor purchases shares in a company, the company does not become a new entity.

Its existing contracts, debts, disputes and compliance history generally remain with it. The investor may acquire control of the company, but that control comes together with the company’s past.

A new shareholder cannot simply say:

“That happened before I joined the company.”

Commercially, the buyer may not have caused the problem. Legally, however, the problem may still affect the company whose shares have been acquired.

Legal due diligence allows the investor to understand that history before becoming committed.

3. When should legal due diligence be conducted?

Legal due diligence is commonly associated with mergers and acquisitions, but its usefulness is much wider.

It may be necessary when:-

• purchasing shares in an existing company;

• acquiring a business or selected assets;

• investing in a start-up or private company;

• entering into a joint venture;

• subscribing for newly issued shares;

• providing substantial financing;

• purchasing commercial property together with an operating business;

• entering into a major distributorship, franchise or supply arrangement; or

• carrying out an internal corporate restructuring.

The scope should reflect the transaction.

An investor acquiring a minority interest may focus heavily on shareholder rights, governance and exit protection. A buyer acquiring the entire company may require a much broader review of historical liabilities. A bank or financier may be more concerned with ownership of secured assets, existing charges and the borrower’s contractual ability to incur additional financing.

There is no single checklist suitable for every transaction.

4. What does a legal due diligence review cover?

The review generally begins with the company’s corporate structure and ownership.

The legal team may examine the constitution, register of members, share certificates, previous share transfers, shareholders’ agreements, board resolutions and records of earlier capital exercises.

The objective is to confirm who owns the company and whether the proposed transaction can lawfully proceed.

Questions may arise such as:-

• Are all shares properly issued and recorded?

• Does another shareholder have a right of first refusal?

• Is board or shareholder approval required?

• Are any shares pledged to a bank or third party?

• Has someone been promised shares that were never formally issued?

• Are there different classes of shares carrying different rights?

These issues can directly affect whether the seller has the ability to deliver what has been promised.

5. Material contracts require more than a quick reading

A business may depend on a small number of contracts for most of its revenue.

The legal team should identify the company’s material agreements and examine matters such as:-

• the remaining contractual period;

• renewal and termination rights;

• exclusivity obligations;

• minimum purchase commitments;

• restrictions on assignment;

• change-of-control provisions;

• indemnity clauses;

• limitation of liability;

• performance guarantees;

• default provisions; and

• governing law and dispute resolution.

A contract shown as a valuable company asset may be terminable on short notice. It may also prohibit a change in control without the customer’s prior consent.

In other cases, the company may have been supplying goods or services for years without a current written agreement. The revenue may be genuine, but its continuation may depend largely on personal relationships rather than enforceable contractual rights.

This distinction matters when valuing the business.

6. Who owns the assets used by the company?

Possession and ownership are not always the same.

A company may operate from a building owned by its founder, use vehicles registered to another related company or rely on software developed by an external contractor.

The business may also use a brand, logo, domain name or social media account that is not legally owned or controlled by the company.

Legal due diligence should identify:-

• the assets required for daily operations;

• the legal owner of each important asset;

• whether any asset is leased, financed or charged;

• whether the company has the right to continue using it;

• whether third-party consent is required; and

• whether ownership or access will be affected by the transaction.

A buyer should not assume that every asset shown in the company’s office or marketing material belongs to the company.

If a critical asset is owned personally by the seller, its transfer or continued use should be addressed in the transaction documents.

7. Licences and regulatory approvals can determine whether the business may continue

Certain businesses require specific licences, registrations, permits or governmental approvals.

The due diligence exercise should verify whether those approvals:-

• have been properly issued;

• remain valid;

• cover the company’s current operations;

• impose conditions that are being complied with;

• can be transferred;

• require notification of a change in ownership; or

• may be suspended following a breach.

A profitable business may lose much of its value if its principal licence cannot be maintained following the transaction.

Where an approval is essential, its renewal or the relevant authority’s consent may need to become a condition precedent to completion.

8. Employment arrangements deserve careful attention

Employees are often central to the value of a business, particularly where the company depends on technical expertise, licences, customer relationships or proprietary knowledge.

The review may cover:-

• employment contracts;

• salaries, bonuses and benefits;

• confidentiality obligations;

• ownership of work product and intellectual property;

• disciplinary matters;

• threatened or existing claims;

• statutory contributions;

• arrangements with consultants and independent contractors; and

• retention of key personnel after completion.

A person described as an independent contractor may, based on the actual arrangement, function more like an employee. A senior employee may also hold essential relationships but have no contractual obligation to remain following the acquisition.

These matters can affect both liability and business continuity.

9. Pending litigation is not the only dispute risk

Court searches may identify proceedings that have already been filed. They may not reveal every possible claim.

A company may have received:-

• a letter of demand;

• a notice of breach;

• a complaint from a customer;

• a regulatory query;

• an employee grievance;

• a threat to terminate a contract; or

• correspondence alleging defective work.

Management should therefore be asked about pending, threatened and potential disputes - not merely cases carrying a court number.

The surrounding documents must also be reviewed. A small claim may expose a wider operational problem, while a large demand may have little legal basis.

Due diligence should assess the nature of the risk rather than merely list the dispute.

10. Related-party arrangements are a common area of concern

In owner-managed businesses, personal and company affairs may become closely connected.

The company may pay expenses for shareholders, borrow money from directors, use property owned by family members or provide services to related companies without formal documentation.

These arrangements may have worked while the business remained under common control. They can become problematic when an outside investor enters the company.

The parties should identify:-

• amounts owing between the company and related parties;

• undocumented loans or advances;

• shared employees and expenses;

• assets used without formal leases;

• services supplied without written agreements;

• guarantees given for another entity; and

• payments made outside ordinary commercial terms.

Before completion, these arrangements may need to be settled, documented, terminated or reflected in the purchase price.

11. Due diligence findings should influence the transaction

A due diligence report should not end with a list of documents reviewed.

Each material finding should lead to a commercial or legal response.

Depending on the issue, the investor may decide to:-

• proceed without adjustment;

• request additional information;

• reduce or restructure the purchase price;

• retain part of the consideration;

• require the issue to be resolved before completion;

• obtain third-party consent;

• request a specific indemnity;

• strengthen the seller’s warranties;

• exclude certain assets or liabilities;

• acquire assets instead of shares; or

• withdraw from the transaction.

For example, an expired tenancy may be addressed by requiring a new lease before completion. A pending tax issue may require a specific indemnity. Uncertain customer retention may justify an earn-out rather than full payment upfront.

Due diligence does not only identify risk. It helps determine how that risk should be allocated.

12. Can warranties replace due diligence?

A buyer may assume that extensive warranties in the sale and purchase agreement will provide sufficient protection.

That assumption can be dangerous.

A warranty claim usually arises after completion, when the buyer has already paid the price and taken over the company. The buyer may then need to establish the breach, quantify the loss and pursue recovery from the seller.

The agreement may also contain financial caps, time limitations, disclosure qualifications and procedural requirements for making claims.

Even a strong contractual claim does not guarantee that the seller will have sufficient assets to satisfy it.

Due diligence aims to identify problems before the transaction is completed. Warranties and indemnities provide contractual protection for risks that remain.

The two serve different purposes and should work together.

13. The seller should also conduct its own legal review

Legal due diligence is not solely for buyers.

A seller may conduct a vendor due diligence exercise before marketing the business. This allows the seller to identify weaknesses, organise records and resolve avoidable issues before they are discovered by a potential buyer.

Advance preparation may include:-

• updating statutory and corporate records;

• formalising related-party arrangements;

• settling shareholder balances;

• renewing important contracts and licences;

• registering intellectual property;

• reviewing employment documentation;

• compiling information on disputes; and

• preparing a structured data room.

A well-prepared seller is usually able to answer questions more efficiently and maintain greater control over the transaction timetable.

Transparent disclosure can also reduce the risk of post-completion claims.

14. Confidential information must be controlled

A due diligence exercise may require the company to disclose customer lists, pricing information, employee data, business strategies and commercially sensitive contracts.

That information should not be released without appropriate safeguards.

Before access is granted, the parties should consider a confidentiality agreement addressing:-

• the permitted purpose of disclosure;

• who may access the information;

• restrictions on contacting employees or customers;

• storage and security requirements;

• return or destruction of documents;

• restrictions on using information if the transaction does not proceed; and

• remedies for unauthorised disclosure.

Access may also be provided in stages. Highly sensitive documents can be withheld until the buyer demonstrates genuine commitment or reviewed subject to additional controls.

Due diligence should provide sufficient transparency without unnecessarily exposing the business.

15. Legal due diligence is not a guarantee that nothing will go wrong

The exercise is based on the documents, information and explanations made available during a limited period.

Its effectiveness depends on the scope of the review, the completeness of the data room and the accuracy of management’s responses.

Undisclosed arrangements, missing documents or deliberate concealment may not be immediately detectable.

For that reason, the buyer should define the scope carefully, ask follow-up questions and ensure that material representations are reflected in the definitive agreements.

The objective is not to certify that the business carries no risk. Every commercial transaction carries risk.

The objective is to ensure that the investor understands the material legal risks before deciding whether - and on what terms - to proceed.

A strong financial performance may explain why a business is attractive.

Legal due diligence helps determine whether that performance rests on rights and arrangements that can survive the transaction.

Before asking only, “How much can this business earn?”, an investor should also ask:

“What could prevent it from continuing to earn?”