Legal Due Diligence: What's So Hard About It and How to Prepare
In earlier posts, we discussed what due diligence was, and then dug into the financial side. Now let's talk about legal due diligence. It doesn’t usually affect price the way a Quality of Earnings analysis can, but it does wear sellers down. The requests are long, and they can highlight problems you didn't know you had.
In this guide, we'll look at why legal diligence is so demanding, where HVAC and mechanical contractors tend to get tripped up, and how to prepare long before the buyer's attorneys send over their first list.
Why Is Legal Due Diligence so Challenging?
Legal due diligence comes with quite a few hurdles that can trip you up on your path to selling. Let's start with the volume. The buyer's counsel wants documentation for everything: contracts, licenses, corporate records, intellectual property, employment agreements, insurance policies, and more. A lot of that paperwork probably hasn't been touched in years. Some of it’s in a filing cabinet, and other documents are in your inbox. Some might not even exist any longer.
Then there's just how specific the requests are. The attorneys don't just want "your customer contracts." They want every contract above a certain dollar amount and every amendment. You probably have most of that information, just not all in one place, and it definitely isn't in the format they're asking for.
You’ll likely reach peak frustration when your attorney starts preparing the disclosure schedules. These are the attachments to the purchase agreement where you list every exception to the promises (the representations and warranties) you're making about your business. If a liability doesn't make it onto those schedules and shows up after closing, the buyer can come after the money held in escrow. So everything has to be found and listed accurately. There's no room for "close enough."
Legal diligence also brings things to light that owners never thought of as problems. An expired license or a handshake deal with your biggest customer that's been running for 15 years with nothing on paper. Maybe it’s a related-party arrangement, like your brother owns one of your key suppliers, a half a page lease to rent part of your office to an engineering firm, or company-paid phones and laptops that double as the family's personal devices. None of these is necessarily a deal-breaker, but each one raises questions, and some need fixes before closing.
What Do Requests Look Like?
A recent IEI client received a list of 123 requested items from the buyer's legal team. That's a pretty typical number. Here's how those requests broke down by category:
Request Category | Number of Requests |
Environmental | 22 |
Intellectual Property | 20 |
Employee Information and Documents | 18 |
Customers and Suppliers | 13 |
Products Liability | 10 |
OSHA | 7 |
Financial Information | 6 |
Litigation | 6 |
Corporate Organization, Documents and History | 5 |
Governmental Regulation | 5 |
Matters Relating to the Company's Securities | 4 |
Property | 4 |
All Other Information | 3 |
Total | 123 |
Environmental led the list, which surprises owners who think of their company as a service provider. For a mechanical contractor, that can mean refrigerant handling and disposal records and the condition of any property you own. Intellectual property came in second, even for companies that don't think they own any. Your business name, logo, website, domain, phone numbers, and software licenses all count. Employee matters were close behind, and keep in mind that each of those 123 line items can require multiple documents.
Issues That Catch HVAC and Mechanical Contractors
For HVAC and mechanical contractors, the following areas tend to generate the most follow-up.
● Contracts: Expect the buyer to go over every service agreement, preventive maintenance contract, warranty obligation, and the contracts behind your large jobs, including change-order documentation. They'll look at supplier and distributor agreements and anything that has your personal guarantee. They'll also look for change-of-control and anti-assignment language. Either one these provisions can give the other party the right to cancel the contract when your business is sold.
● Licenses/Permits: Buyers want to see your contractor licenses, journeyman and master certifications, technicians' EPA Section 608 refrigerant certifications, and more. If you operate across state lines, expect to show compliance in each state. They'll also want to know whose name the qualifying license is under. If it's held personally by you and you're planning to step away, that's something to deal with early.
● Employment Matters: If you have union agreements, those will get a careful read, as will your 1099 technicians. The IRS looks at how much control you have over how the work is done, how the worker is paid and equipped, and the nature of the relationship, since a misclassification can leave the business on the hook for back employment taxes. Buyers will also want to know which of your key employees have employment agreements or non-competes.
● Corporate Housekeeping: These are things like questions about who owns what, missing corporate minutes, undocumented ownership changes, etc. If a partner was bought out on a handshake a decade ago, the paperwork needs to reflect that.
● Litigation History and Liens: Buyers usually run lien, judgment, and litigation searches, so anything on the record will come up. Mechanic's liens, customer disputes, and warranty claims all need an explanation and documentation showing how they were resolved.
● Insurance and Bonding: Gaps in your coverage history raise questions about exposure during those periods. If you do bonded work, expect questions about your surety bond capacity and whether it will carry over.
● Real Estate and Leases: If the buyer is evaluating your facilities, your lease will get a close look, especially if you own the building yourself or share space with other businesses.
How Can Owners Prepare?
The good news is that almost all of this can be handled ahead of time.
● Loop in transaction counsel early. Start a legal clean-up pass months before you go to market, not after you've signed an LOI.
● Build a data room early. Organize all your documents in one place.
● Have your contracts reviewed. Ask your legal team or advisor to comb through your agreements so nothing catches you off guard.
● Get key agreements in writing. If you have verbal arrangements with major customers, formalize them.
● Fix known issues before the buyer finds them (renew expired licenses, track down missing signatures, etc.).
What Is the Advisor’s Role?
Legal diligence doesn't exist in a vacuum. It happens at the same time as financial diligence, operational diligence, and everything else the buyer has in motion, all while you're still trying to run your business.
A good advisor paces the overall process so you're not tackling everything all at once. They capture the documents you've already provided for other diligence requests and pass them along to the legal team, which cuts down on duplicate requests. They provide progress tracking across all one hundred plus requests: what's in process, complete, not started, or was recently added as a follow-up request.
The advisor also organizes the data room so attorneys can find what they need for the disclosure schedules. And when a disclosure request looks like it's going to be time intensive data crunching and organizing, the advisor's team tackles the heavy lifting to save you on legal fees.
Just as important, an advisor translates. Your advisor can tell you what documentation a request is really asking for and help you separate what's necessary from what's overkill.
You Can Get Through Legal Due Diligence
Legal due diligence is tough because it's in-depth, not because something is wrong with your business. The buyer's attorneys are doing their job, and a long list of requests is a normal part of every deal. The owners who get through it with the least pain start early and have the right people in their corner.
If you're thinking about selling in the next year or two, now is the time to start a legal pre-diligence process. Reach out, and we'll talk through what that looks like for your business and help you find an experienced transaction attorney for support. You can also ask us for a sample legal due diligence request list so you can see exactly what's coming.
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