What is Legal Due Diligence? Legal Due Diligence in a Company Acquisition Transaction

You have agreed on the transaction price, reviewed the financial statements and the company’s operations. Is that enough to safely acquire a company? Not always. Legal due diligence often identifies risks that are not visible in financial data or company presentations.

In my practice, I often see that most of the time in a transaction is not spent discussing the purchase agreement itself, but rather on organizing documents after deficiencies have been identified during legal due diligence. It often turns out that it is necessary to update board or shareholder decisions, conclude intellectual property transfer agreements, obtain creditor consents, or clarify the terms of long-standing contracts.

Risks can be significantly reduced by conducting legal due diligence appropriate for the transaction and, if necessary, other types of due diligence.

What types of due diligence exist?

In company acquisition transactions, the buyer may conduct several types of due diligence depending on the specifics of the transaction. The most important is Legal Due Diligence (LDD), which assesses the company’s legal status, material contracts, corporate structure, ownership, licenses, employment relationships, intellectual property, and other legal risks. Alongside this, Tax Due Diligence is often conducted, which analyzes the company’s tax risks and liabilities. Depending on the nature of the transaction, the buyer may also conduct Financial Due Diligence, Commercial Due Diligence, Technical Due Diligence, or Operational Due Diligence. In this article, we will look more closely at Legal Due Diligence.

Why do buyers conduct Legal Due Diligence?

Firstly, when acquiring capital shares or stock, the buyer obtains not only the company’s assets and clients but also its legal history. After the transaction, the target company retains previously concluded contracts, rights, and assets, but at the same time, it also retains its liabilities, previously committed infringements, and potential disputes. If the buyer does not have information about these risks, they will be a big surprise to deal with after the transaction is completed. Most often, entirely at the buyer’s expense.

Secondly, legal due diligence allows for the timely identification of risks that have not yet materialized. A risk does not necessarily have to be recorded or have turned into litigation. It can arise from a breach of contract for which the other party has not yet made a claim, or from a tax risk that the State Revenue Service has not yet audited; or improperly formalized intellectual property rights; non-compliance with license or permit conditions; employee claims; inappropriate personal data processing; environmental or construction requirement violations; guarantees, commercial pledges, or other off-balance sheet liabilities.

These findings are also reflected in international studies. SRS Acquiom’s 2024 M&A Claims Study analyzed over 850 private target company acquisition transactions with a total value of $168 billion. At least one indemnification claim raised after the transaction was completed was found in 28% of transactions.

Also, in the Berkeley Research Group’s 2025 M&A Disputes Study, which involved 209 lawyers, private equity professionals, and corporate finance consultants, 37% of respondents indicated that circumstances related to the due diligence process were common in the M&A disputes they handled in the previous year.

For example, a common situation in practice is when a company has been successfully operating for more than ten years, but legal due diligence reveals that the main trademark is registered in the name of the company’s founder, not the company itself. In such cases, the transaction is usually not terminated, but the transfer of intellectual property must be arranged before its completion.

Finally, legal due diligence provides the buyer with a complete picture of the company it plans to acquire. Significant penalties in a supply contract change its financial risk model; reliance on state aid can also mean future obligations for the buyer. Presenting a few documents or a general introduction to the company’s operations does not mean that the buyer has understood the legal significance of these documents and circumstances. Financial statements can show how much a company has earned. They do not, by themselves, confirm that the company owns all the assets it uses, that material customer contracts will continue after a change of control, that licenses necessary for operations are valid, or that there are no undisclosed liabilities, collateral, and disputes. The purpose of legal due diligence is not to look for deficiencies, but to find out what the buyer is actually acquiring, what risks come with the company, and how these risks affect the price, transaction structure, and seller’s liability.

In practice, only in rare cases does legal due diligence reveal risks that prevent the transaction from happening at all. Much more often, the results of legal due diligence change the economic terms of the transaction – the purchase price, the scope of warranties, liability limits, or conditions that must be fulfilled before the transaction is completed.

What is Legal Due Diligence?

Legal Due Diligence is a legal review of a company before acquisition, aimed at identifying risks that may affect the company’s value, transaction price, and the parties’ liability. In practice, legal due diligence most often does not affect whether the transaction will take place. It affects the transaction price, seller’s warranties, and who will bear the identified risk after the transaction.

The precise scope of LDD is determined by the target company’s industry, transaction value, geographical scope of operations, and buyer’s plans. In an energy project, LDD often begins with checking land use rights, connection documentation, and project permits. In a technology company, intellectual property, developer agreements, and software licenses will be a priority. Typically, legal due diligence covers the following areas:

1. Corporate structure and ownership of capital shares. Corporate documents themselves rarely pose the greatest risk. More often, problems arise when the articles of association, shareholder register sections, and shareholder agreement do not align. In medium-sized private companies, it is common for the company’s daily operations to be successful, but corporate documents have not been fully updated for several years. Most often, this does not stop the transaction but requires additional work before its completion.
2. Financing, commercial pledges, and other collateral. The due diligence analyzes loan agreements, credit lines, guarantees, pledges, mortgages, financial leasing, and related party financing.
3. Material customer and supplier contracts. One of the most common risks is material customer or financing contracts that stipulate that the consent of the other party is required in the event of a change of ownership, or that the contract may be terminated. Failure to identify such provisions can significantly affect the company’s value after acquisition.
4. Intellectual property and IT. In technology, e-commerce, financial services, and professional services companies, a significant part of the company’s value may be software, trademarks, domains, databases, and trade secrets. The due diligence checks whether intellectual property rights belong to the company, not its founder, employee, or outsourced service provider. Software development agreements, license terms, open-source software, data protection, and cybersecurity incidents are also analyzed.
5. Employment law and management team. Employment contracts, board member relationships, remuneration and bonus systems, unused vacations, non-compete restrictions, employee stock or option programs, and potential disputes are reviewed.
6. Real estate, environment, and construction. If the company’s operations are related to manufacturing, logistics, agriculture, energy, or real estate, ownership and usage rights, lease agreements, encumbrances, building permits, commissioning, and environmental requirements are checked.
7. Licenses, permits, sanctions, and regulated industries. In financial, insurance, energy, gambling, pharmaceutical, food, transport, and other regulated industries, licenses, permits, regulatory decisions, and the potential need to obtain consent for a change of ownership must be checked.

How does the Legal Due Diligence process work?

First, the scope of the due diligence is determined, defining the companies to be reviewed, areas of law, period, materiality thresholds, and report format. Then, a document and information request adapted to the company’s operations is sent to the seller, as the standard list is only a starting point, and the scope of due diligence can vary significantly for manufacturing, technology, energy, or real estate companies. Documents are uploaded to an electronic data room, where they are analyzed. Finally, a due diligence report is prepared, classifying risks by their legal and financial impact, while also indicating not only the identified problem but also the recommended solution and its reflection in the transaction documents.

How do the results of legal due diligence affect the purchase agreement?

The practical value of legal due diligence arises when its findings are used in transaction documents. For example, a risk identified by LDD can be addressed by a reduction in the purchase price or an adjustment mechanism; an obligation to remedy a deficiency before the transaction is completed; creditor, client, or regulator consent; seller’s representations and warranties; a specific indemnification obligation; escrow of part of the price or an escrow account; postponement of transaction completion; or the right to terminate the agreement if a material risk is not remedied.

All of the above indicates that a well-conducted LDD is not a formal document review stage. It is the basis for the buyer’s decision, the justification for the transaction price, and the allocation of risks between the buyer and seller. The results of the due diligence determine which circumstances must be remedied before the transaction, what warranties the seller must provide, what information must be properly disclosed to the buyer, and which party will bear the economic consequences of a specific risk after the transaction.

In a company acquisition transaction, LDD is not an expense. It is an investment in information. The transaction price is based on assumptions, while the task of legal due diligence is to verify which of these assumptions are true. The earlier risks are identified, the more opportunities there are to resolve them before the transaction, rather than after. Well-conducted legal due diligence not only reduces risks but also gives the buyer confidence that the transaction price corresponds to what they are actually acquiring.

In subsequent articles, we will separately analyze the importance of legal due diligence for the buyer, the benefits for the seller, examine what Vendor Due Diligence is, and address other M&A issues.

If you are planning to acquire or sell a company in Latvia, the scope and focus of legal due diligence should be determined at the very beginning of the transaction. Risks identified in a timely manner almost always cost less than those discovered after the transaction is completed.