How to conduct a legal due diligence of a startup?

Contents:

1. When is it advisable to carry out Legal Due Dilligence;
2. Tasks that legal audit solves;
3. What information is subject to verification during Due Dilligence?
4. What points should you pay attention to?
5. Legal Due Dilligence before assuming the position of CEO of the company;
6. Is it obligatory to carry out Legal Due Dilligence for a startup?

How to conduct a legal due diligence of a startup?

Legal Due Dilligence of a startup is advisable in the following cases:

1. You are looking to acquire a third party company or an equity stake in it.
2. You are the founder of a startup and are planning to sell or raise investment.
3. The conclusion of an M&A deal with the participation of the company is being considered.
4. You are about to take over as CEO of a company.

Tasks solved by legal audit

Due Dilligence is useful for both the business owner and the initiator of the audit, which can be a potential investor or buyer. Thanks to a legal audit, you can analyze in detail business processes, identify risk factors that can negatively affect the company's activities. Based on the data obtained, the founder of the project develops measures to reduce risks. The audit helps to assess the condition of assets and determine the value of the enterprise. This is necessary when preparing for sale and purchase transactions to justify the price offer.

Legal audit also helps to identify shortcomings in the development of legal documentation and to eliminate them in a timely manner.

What information is subject to due diligence verification?

A start-up due diligence includes the verification of documents provided by the auditee. Data from free sources and the results of communications with employees are also used.

What points should you pay attention to?

The scope of the due diligence check is justified by the goals and objectives of this event. The procedure can take one to two days or last several weeks - it all depends on the size of the business. If a check is done before investing in a startup, the following points need to be analyzed:

• State registration of a legal entity

Documents related to business registration, constituent and internal documents, changes that were made to the Unified State Register of Legal Entities are checked. It is also necessary to analyze the financial documentation that relates to the formation of the authorized capital, the conclusion of large transactions.

• Legitimacy of the company

If we are talking about startups, then the implementation of the project may be hampered by restrictions that are associated with current legislation. This issue must be given due attention and an objective assessment of the risks before investing in a project.

• Labor Relations

Personnel documents, which determine the procedure for registration of employees, are subject to verification.

• Assets

It is necessary to check not only tangible, but also intangible assets: trademarks, logos, other types of intellectual property. Property rights must be confirmed by patents and other legal documents.

• Relations with government agencies and counterparties

It is necessary to assess the risks of filing claims against the company by the tax authorities and other regulatory authorities. The conditions of contracts with contractors, litigation are also checked.

Legal Due Dilligence before the CEO takes office

As part of the procedure, it is necessary to analyze the financial position of the organization. The check will help to identify the possible existence of debts to employees, suppliers or customers, to determine the quality of accounting and tax reporting. It is also worth paying attention to the presence of ongoing litigation and claims from the regulatory authorities.

In the future, this will help the new CEO to protect himself from unfounded claims and claims for damages that have arisen due to the wrong actions of the former head of the company. If deficiencies have been identified, the results of the audit must be brought to the attention of the founders and shareholders.

Is it obligatory to carry out Legal Due Dilligence for a startup?

In the West, this practice is used everywhere. In our country, legal audits are resorted to only before major transactions, and in other cases, the parties do not want to incur additional costs or waste time waiting.

In general, this is quite risky. Despite the seller's assurance that there are no risks, after signing the deal, unsightly facts about the presence of debts or claims from third parties may open up. In some cases, the transaction may be declared invalid at all due to violations in the registration of property rights by the previous owner of the assets.

Of course, the Legal Due Dilligence procedure is not capable of 100% protection against risks, because the audited company may resort to hiding information. To avoid losses, we advise you to include in the agreement a section "Representations and guarantees". This possibility is regulated by article 431.2 of the Civil Code of the Russian Federation. If one of the parties to the transaction has shown bad faith, the injured party has a legal basis to recover compensation for damages in court.

The A4 Law Firm team of lawyers will assist you in preparing and organizing a legal audit of a startup.