Due Diligence: Part Five, Financing Documents

By Jeff Wolfe

At the Forrest Firm, we often represent clients as they negotiate and enter into strategic transactions with other companies, such as mergers and acquisitions, strategic alliances, and joint ventures and licensing. One of our most important jobs as corporate attorneys is guiding our clients through the process of due diligence associated with these types of transactions, especially regarding the mergers and acquisitions that occur between companies on a regular basis.

Our series of articles focusing on due diligence first discussed the big picture, taking an overall view of the process and its proper execution in the context of a strategic transaction. Next, we looked at due diligence with specific regard to assignment and change of control provisions. Most recently, we discussed the importance of corporate records and commercial contracts. This week, let’s take a look at financing documents.

Financing documents include both equity financings and debt financings. For equity financings, the documents to review should include stock purchase agreements, subscription agreements, and other ancillary agreements (e.g., investors’ rights agreements and voting agreements). Stock purchase agreements are particularly helpful since they show representations the target company has previously made, as well as any information made known in the disclosure schedules. Private placement memorandums or other diligence provided to equity investors can also be helpful in the due diligence review process since these documents should paint an accurate picture of the target company at the time of the equity financing. Based on a review of this documentation, along with stock option plans, stock option agreements, and other equity compensation documentation, legal counsel should be able to track the ownership reflected on the target company’s capitalization table.

For debt financings, the principal documentation should include documents showing debt—loan agreements, credit agreements, promissory notes, and the like. In addition, the due diligence review should include correspondence with lenders, specifically any compliance certificates or reports submitted to lenders by the target company. For bank debt, it may be important to review initial agreements, plus any amendments, renewal letters, and statements.

When reviewing debt documentation, the primary motive is to determine the amount of money the target company owes or has guaranteed and the terms and conditions related to repayment (i.e., checking for a pre-payment penalty). If the buyer chooses to assume the debt instead of requiring the target company to pay off the debt at closing, then the assignment provisions will need to be reviewed regarding events of default, which may be triggered by the proposed transaction. The proposed transaction may also be restricted or adversely impacted by the debt documentation. Lastly, the covenants in the debt documentation will be important for the buyer going forward.

A Uniform Commercial Code (UCC) lien search should turn up any secured debt, which may include general debt financing covering all of the target company’s assets or equipment leases or other financial arrangements related to specific assets. To the extent there are liens on assets, the process for releasing these liens should be determined.

If you’re looking for help with due diligence on your next strategic transition, please feel free to contact me at the Forrest Firm.  Look for our next installment of the series coming soon, where we’ll discuss due diligence regarding intellectual property.