Why should a business conduct Due Diligence, even if there is no potential investor on the horizon?

There are two global misconceptions: the fact that Igor Nikolaev, in his song of the same name, talks about five reasons for lost love (in fact, there are eight of them), and also that legal Due Diligence is important and needed only by the buyer and only directly in the process of an M&A transaction.

Based on our extensive practice (we have closed more than 100 M&A transactions in different jurisdictions), Due Diligence is indeed carried out in the context of a specific transaction initiated by the buyer. At the same time, the percentage of requests for internal Due Diligence of a company that has nothing “on fire” is several times smaller.

At first glance, the reason for such an advantage lies on the surface: why pay lawyers for an optional procedure if everything seems to be working somehow. Especially if the company has an in-house lawyer or even a legal department. Moreover, if the company conducts an audit of financial statements at least occasionally.

We find that business owners, especially startups and small companies, often do not realize the full potential and benefit they can receive from conducting internal Due Diligence without a clear urgent need. This is due to a lack of awareness of the benefits a proactive approach to managing the legal aspects of a business can bring.

So, music and idea — Igor Nikolaev, experience — lawyers of REVERA Law Group.

8 reasons to conduct internal Due Diligence.

"The first reason — it's you" or the vices of the company itself

In many countries, especially in the post-Soviet space, there is a declarative principle for registering legal entities. Foreigners admire the speed and simplicity of this principle and are simply jealous — I downloaded the standard charter from the Internet, took my passport, and in half an hour while waiting for my turn, filled out an application, the form of which is here. And now you are already a respected founder of the company with a colored certificate and a stamp on the charter.

But this simplicity is fraught with the main danger — your documents are not checked. That is, by signing the registration documents, you confirm the accuracy of the submitted information and assume all risks associated with the consequences of submitting information.

And the risks are serious — a company registered in violation of the law bears the burden from the very beginning in the form of the potential possibility of being liquidated due to the recognition of its state registration as invalid. Of course, it would be better for business owners to know about this in advance, because it may come to light completely unexpectedly, and only after it cannot be corrected.

And this is just one example of “red flags” companies that lawyers can identify (and not only identify, but also offer elimination options).

"Second reason — all your dreams" or inadequate assessment by the company's owners.

We are talking about valuing the company in monetary terms.

When evaluating companies, not only cost indicators are taken into account, which allows us to obtain something close to the real value of the business. The legal integrity of the company, the state of its assets and internal processes related to legal issues, as well as the risks of litigation and conflicts with government agencies can significantly affect the market value of the business. Lack of documentation and chaos in management can greatly reduce the interest of potential buyers or negatively affect the value of the business.

"The third reason — all your words" or when rights to IP objects are not properly registered.

We would like to emphasize only one thing: without proper registration, all rights to intellectual property objects arise from their creators — your employees or contractors, and do not belong to the legal entity.

To avoid disputes over the rights to works, for example, with a former employee, conduct an internal audit and ensure the security of your intellectual property. This will allow you to calmly respond to threats of lawsuits and maintain control over your IP products.

"The fourth reason — this is a lie" or dishonesty of hired personnel.

Everyone lies. If they are not lying, then they are not telling. With the best intentions, to cover up your mistakes, and sometimes for personal gain.

It happens that you do not know about the company’s debts due to insufficient information from the accounting department and missed deadlines from the lawyers. You hope that this money will be returned to you at least someday, but in fact you have a “dead” money. debt that can only be written off.

If you have a hired director, it is important to conduct an internal audit, even if you trust him. “Trust, but verify,” especially when you are constantly asked for money to cover business expenses.

Contracts with suppliers and contractors should be reviewed every couple of years to ensure they are consistent with market conditions and do not conceal asset stripping schemes. In general, after an internal due diligence you will be able to learn a lot about your company.

"The fifth reason — this is a pain” the pain of all companies that lack adequate document flow.

It really hurts. And, if you think that a working business model without proper legal registration will help you create an empire, then most likely you are the owner of a startup with a small team.

As your business scales, it becomes critical to keep your documents in order. You must have protocols, key agreements, a list of affiliates, final beneficiaries and all their data, and many other documents that a bank, a counterparty with its own internal KYC procedure, or government agencies will suddenly request from you.

And don’t forget about the requirements for the formal presence of certain documents in the office, production, retail premises or in general in the company — regulations, rules, instructions, magazines, certificates, policies, etc. You may have never even heard, for example, about instructions for waste management, and for its absence you will definitely be fined.

Internal due diligence allows you to systematize and fill in gaps in key documents, ensuring more efficient business management and risk reduction.

"The sixth reason — this is your new love" or if one type of activity is no longer enough.

An internal due diligence may be useful if your company enjoys a special tax regime or is registered in a special economic zone, where there are usually restrictions on engaging in activities other than those declared. This category also includes activities that require certification or licensing.

Lawyers will be able to analyze your activities and draw a conclusion whether you are violating the law in this regard.

"The seventh reason — these are all your friends.” or how corporate issues are resolved between the owners.

The key to a successful resolution of a corporate conflict — this is his non-admission. Periodically, you need to review your charter to determine how it covers issues of corporate governance and other important aspects of the joint business life of the participants: voting on key company issues, the procedure for making decisions on the exit of existing participants and the admission of new ones, additional financing of losses. , preemptive rights to repurchase shares (stakes).

Charter, “customized” to suit the needs of your business — This is exactly the mechanism that helps eliminate most conflicts, and it is never too late to create it.

"The eighth reason — it's me" like any potential investor or buyer.

Yes, we set ourselves the task of indicating the value of the legal due diligence without any connection with the transaction, but it cannot be denied that a preliminary check of the company will make your business more attractive to investors and buyers. This demonstrates your responsibility and willingness to collaborate on a professional level.

To summarize, an internal accountant can be not only a means of solving current problems, but also a tool for creating long-term value and increasing the attractiveness of your company in the market.