How to conduct legal due diligence: Checklist and best practices
Imagine this: you found the perfect company to acquire. The numbers look great, the synergy is promising, and the deal seems instantly beneficial. However, as soon as the deal closes, hidden legal issues pop up — an undisclosed lawsuit, unclear intellectual property (IP) rights, or a compliance problem. And just like that, a dream partnership becomes a financial and legal burden.
Legal due diligence (LDD) is a shield that can protect buyers and sellers from such risks. Conducting a thorough legal investigation helps you discover potential legal problems and lets you react proactively. For instance, the timely detection of certain issues was one of the reasons for the termination of the AbbVie and Shire deal in 2014.
This article describes the fundamentals of legal due diligence, specifies the main phases, and provides a sample legal due diligence checklist to use for inspiration.
What is legal due diligence?
Legal due diligence reviews and analyzes a company’s legal aspects before a merger, acquisition, or investment.
It involves examining employee contracts, regulatory compliance, litigation history, intellectual property, vendor contracts, and other legal documents to identify potential liabilities and risks. The goal is to ensure no hidden issues could impact the transaction or the future of the business.
Conducting a legal due diligence review is essential, since missing certain problems can harm deal outcomes and pose significant risk to the company’s operations and reputation.
Imagine an investor is considering buying a technology company. During LDD, they discover that the company doesn’t fully own the rights to its core software because it was developed by third-party contractors without proper agreements. Without this information, the investor might overpay or face legal disputes later.
Instead, by uncovering this risk early, the investor can renegotiate terms, demand corrective actions, or even decide to walk away from the deal.
Sell-side legal due diligence
Sell-side legal due diligence is when a company getting ready to sell proactively reviews its legal documents to spot and fix any potential issues before the buyers do.
By doing this ahead of time, the seller can solve problems, show the acquiring company that everything is in order, and negotiate better terms. It helps make the deal process smoother and successful.
Buy-side legal due diligence
Buy-side legal due diligence is when a buyer reviews the legal aspects of the selling company to ensure there are no hidden risks or problems.
The buyer uses due diligence investigations to decide if the deal is worth it, adjust the offer, or walk away if the legal risks are too high. It helps the buyer protect their investment and avoid future legal troubles.
Who performs legal due diligence and how long it takes
The legal due diligence process can take anywhere from a couple of weeks to several months. It depends on the target company’s size, the complexity and structure of the deal, and whether any bottlenecks are discovered during the investigation.
For instance, a prospective buyer might stumble upon unclear ownership of assets or some critical documents might be missing. Both cases will require additional clarification, which will inevitably lead to delay.
Who is responsible for conducting legal review? In most cases, any of the following parties can perform legal due diligence:
- In-house legal team
In-house legal professionals are familiar with the company’s operations, contracts, corporate documents, and compliance history. For sellers, the in-house team plays a key role in organizing and preparing documents for due diligence. They can also address potential risks proactively to present a clean profile to potential buyers. - External law firm
These are independent legal organizations hired to conduct a detailed and unbiased review and share their legal opinion on the deal’s potential. They bring specialized expertise and resources that may not be available in-house. Buyers often rely on external law firms for a very thorough due diligence conducted with an expert eye. Sellers also may hire them to prepare for their own due diligence or to address complex legal issues. - Compliance experts
These third parties ensure compliance with all applicable laws, regulations, and industry standards by reviewing licensing, permits, regulatory filings, and internal processes. Their work is especially critical in industries with strict oversight, such as healthcare, finance, or energy, where non-compliance can pose significant risks to a transaction. - Specialized legal advisors
These focus on specific legal areas, such as intellectual property, tax law, employment law, or environmental law. Their expertise is invaluable for addressing technical or niche issues that may arise during due diligence. For example, an intellectual property lawyer might review patents and trademarks to ensure ownership and protection are clear. - Industry-specific legal professionals
These are legal professionals with knowledge of the legal and regulatory challenges unique to certain sectors. For instance, in the pharmaceutical industry, such experts might examine compliance with drug safety regulations. Their insights help identify risks that a general legal team might overlook, ensuring a more thorough evaluation.
Main steps to conducting legal due diligence
The legal due diligence process might be slightly different in public and private deals. However, the main stages of LDD are similar.
Planning and preparation
The legal due diligence begins with defining the goals and scope of the investigation.
The buyer or seller identifies the key areas to review, such as contracts, intellectual property, regulatory compliance, and ongoing or past litigation. A detailed due diligence checklist is created, timelines are set, and a legal due diligence team is assembled to perform the review.
Document request and collection
To initiate the process, the buyer issues a due diligence request list, which specifies all necessary legal documents the target company is asked to provide.
These may include contracts, governing documents, employee agreements, intellectual property registrations, permits, licenses, and details of pending or past legal disputes. The collected documents are usually organized in a secure centralized cloud space such as a virtual data room (VDR) for efficient access.
Document review and risk identification
The legal team thoroughly examines the provided documents to identify risks, discrepancies, and potential liabilities.
They look for issues like unclear ownership of assets, non-compliance with regulations, unresolved legal disputes, or gaps in contracts. Any missing or incomplete documents are flagged, and follow-up requests are made to ensure a complete review.
Interviews and clarifications
The acquiring company’s due diligence team may conduct interviews with the target’s key stakeholders, such as executives, legal representatives, or department heads, to gain additional context or clarify unclear information.
This step helps address arising questions and uncover insights that might not be clear in the documents.
Risk assessment and prioritization
After completing the review, the team evaluates the identified risks based on their severity and potential impact on the deal.
Risks can be categorized as critical, moderate, or minor, which helps the buyer or seller understand which issues need immediate attention or could be a potential dealbreaker.
Reporting findings
The due diligence team compiles investigation results into a comprehensive due diligence report.
The report summarizes key findings, highlights major risks, and offers actionable recommendations. It may suggest ways to mitigate risks, such as renegotiating contract terms, obtaining warranties or indemnities, or requiring corrective actions before the deal closes.
Decision-making and next steps
Based on the due diligence report, the buyer or seller decides how to proceed.
Buyers may renegotiate the purchase price, request additional protections, or decide not to proceed if the risks are too great. Sellers can use the findings to resolve issues, improve their legal profile, or strengthen their negotiation position.
Legal due diligence checklist
A due diligence checklist is a structured tool that helps ensure nothing is missed during the investigation.
This table is an example of what a legal due diligence checklist looks like. You can use it for inspiration when creating the one for your deal, customizing it based on your requirements and needs.
| Category | Checklist items | Notes |
| Corporate documents | Articles of Incorporation and bylaws (and amendments) | Ensure these are up-to-date and legally compliant |
| Corporate governance policies and procedures | Check for adherence to applicable laws and internal controls | |
| Governing documents (operating agreements, partnership agreements) | Ensure clear structure and delegation of authority | |
| List of shareholders and shareholder agreements | Review rights, obligations, and restrictions in these agreements | |
| Board meeting minutes and resolutions (from the past 3-5 years) | Look for major decisions or unresolved issues | |
| Certificates of good standing in relevant jurisdictions | Verify the company’s legal standing to operate | |
| Contracts and agreements | Material customer, supplier, and vendor agreements | Identify terms, risks, and termination clauses |
| Employment contracts for key personnel | Look for retention risks or unusual terms | |
| Non-compete, non-solicitation, and confidentiality agreements | Verify enforceability and scope | |
| Joint venture and partnership agreements | Ensure obligations and rights are clearly defined | |
| Loan and credit agreements, including debt details | Assess financial obligations and risks | |
| Real estate and equipment leases | Review termination, renewal terms, and associated liabilities | |
| Intellectual property | List of registered trademarks, patents, copyrights, and domain names | Ensure these are up-to-date and owned by the target |
| Agreements related to IP licensing or assignments | Check exclusivity, royalties, and termination rights | |
| Evidence of ownership for core technology or software | Verify that IP is free of claims or disputes | |
| Details of IP disputes, claims, or litigation | Understand their potential impact on business operations | |
| Regulatory compliance | Copies of all required licenses, permits, and registrations | Ensure the business operates within legal parameters |
| Documentation of data protection and privacy practices | Check for compliance with regulations like GDPR or CCPA | |
| Records of past regulatory inspections or violations | Identify patterns of non-compliance | |
| Litigation and disputes | List of ongoing or past legal disputes and litigation | Assess financial or reputational risks |
| Copies of court filings, judgments, or settlement agreements | Verify resolutions and financial impact | |
| Details of threatened legal claims | Assess potential liability | |
| Employment and labor | Employee list with roles, salaries, and benefits | Look for discrepancies or overexposures in compensation |
| Collective bargaining agreements | Check for union-related obligations or risks | |
| Records of past labor disputes or claims | Review trends or unresolved issues | |
| Compliance with local employment laws | Confirm adherence to applicable labor regulations | |
| Financial health | Audited financial statements (past three or five years) | Review income statements, balance sheets, and cash flow statements |
| Management accounts and budgets | Assess alignment with financial forecasts | |
| Analysis of debts, loans, and repayment schedules | Check for financial stability and risks | |
| Details of contingent liabilities and obligations | Review potential financial impacts on the transaction | |
| Real estate and assets | Titles, deeds, and leases for real estate | Ensure ownership or terms of lease are valid |
| Documentation for major equipment purchases | Verify ownership and depreciation details | |
| Details of mortgages or liens on assets | Check for obstacles that could affect the valuation | |
| Insurance | Copies of current insurance policies | Review the scope of coverage and exclusions |
| Claims history for all insurance coverage | Assess patterns of risk or negligence | |
| Other relevant areas | List of subsidiaries, joint ventures, or affiliated entities | Check for financial or operational dependencies |
| Anti-corruption, bribery, and whistleblower policies | Ensure compliance with international standards like FCPA | |
| Evidence of cybersecurity standards | Identify potential vulnerabilities or data breaches | |
| Details of major customer or supplier dependencies | Assess risks of over-reliance on a single party |
Conduct legal due diligence with Ideals
Ideals’ due diligence data room provides a secure space for storing and sharing confidential and highly sensitive legal data during due diligence.
Besides that, Ideals also offers:
- Productive collaboration
Due diligence participants can effectively communicate in the Q&A section by posting questions, assigning experts, and getting prompt answers. - Real-time reporting
Virtual data room administrators can monitor document and user activity in real time, which allows the sell side to identify the potential interest of the buy side and react proactively. - Due diligence checklist functionality
Users can upload existing XMSL checklists into the VDR without conversion, preserving familiar workflows and making real-time changes within the VDR so that all the stakeholders stay on the same page. - Complete access management
Ideals offers eight levels of access permissions, which ensure only authorized parties can view confidential information.
Source: Ideals Help Center
Key takeaways
- Legal due diligence is the process of reviewing and analyzing a company’s legal aspects before a merger, acquisition, or significant investment.
- Legal due diligence is typically performed by in-house legal teams, external law firms, compliance experts, specialized legal advisors, or industry-specific legal professionals.
- The main stages of legal due diligence are planning and preparation, document request and collection, document review and risk identification, interviews and clarification, risk assessment and prioritization, reporting findings, decision-making and next steps.
- Common areas of legal due diligence include corporate documents, contracts and agreements, intellectual property, regulatory compliance, litigation and disputes, employment and labor, financial health, real estate and assets, insurance, and other relevant areas.
- Legal due diligence is best conducted in a virtual data room that provides secure storage, collaboration capabilities, real-time reporting, access controls, due diligence checklists, and more.
FAQ
A due diligence checklist is a list of tasks and documents that need to be reviewed during due diligence. It helps ensure that all important legal aspects are thoroughly checked before finalizing the transaction.
The main types of due diligence include legal, financial, operational, and commercial. Legal due diligence focuses on contracts and compliance and financial checks on the company’s finances; operational looks at day-to-day processes; and commercial reviews market conditions and potential risks.
Typically, the buyer pays for due diligence costs. This includes hiring legal, financial, and other experts to thoroughly review the business before the deal. In case the seller decides to conduct proactive LDD, they will pay for their own.
The cost of due diligence can vary, depending on the size and complexity of the deal. For smaller deals, it might cost a few thousand dollars, but larger transactions can run into the tens of thousands.
Yes, lawyers often handle the legal aspects of due diligence. They review contracts, intellectual property, compliance issues, and any legal risks that might affect the deal.