Private equity investment seeks to provide growth to unlisted entities with a view to securing good returns on behalf of the investors in the private equity fund within a pre-defined time. Private equity in many scenarios can be a win-win for both the founder and the management team of the unlisted entity, enabling the business to grow with the support of experienced investors and generating significant financial uplift for all shareholders on the ultimate exit [1]. Private equity funds are often structured as limited partnerships, with partners taking an active role in the operations of portfolio companies or unlisted entities. Investors in Private equity firms/companies include high-net-worth individuals, pension funds, charitable endowments and sovereign wealth funds. 

Due diligence is a significant and important term in the world of finance and private equity especially. Diligence refers to an investigation or in a layman’s term an audit of the company’s financial documentation. It implies research and fact-checking of a specific product or investment. In today’s modern transaction business transacting parties are bound to conduct due diligence by law particularly in transactions as sensitive as Private equity transactions. Due diligence is the set of investigating procedures which precede a private equity transaction. Accordingly, it is the process of identifying and confirming or disconfirming the business reasons for a proposed capital transaction. The purpose of due diligence investigation is to enable the purchaser gain sufficient familiarity with the target company’s affairs to assess the risks involved in the purchase[2]. The aim of due diligence is to confirm all material facts, claims and assertions put forward by the other side. 

In contemporary Private Equity transactions, private equity industry consists of high net players, institutional investors, private firms and pension funds among others. Due diligence plays a massive role in private equity because it helps determine and create a value of specific equity. It is important to note that it is not compulsory to conduct due diligence. It would however be foolhardy not to do so in order to avoid finding the skeletons and uncovering potential deal breakers, but also it is important to assess the value of the company and discover valuable documentation that clarifies any inaccuracies of the financial status of the company as well as any potential fraudulent activities of the Company, criminal conduct and whether the company has complied with the relevant regulatory agencies. 

Due diligence is the process of verification, investigation, or audit of a potential deal or investment opportunity to corroborate all facts, financial information, and to verify anything else that was brought up during a transaction deal or investment process [3]. The Due diligence of a particular company occurs at the inception of a particular transaction in view to provide the buyer assurance before making an investment in the company to enable the investigator gain sufficient familiarity with the target’s affairs to assess the risks involved in the transaction. The importance of due diligence is often belaboured given the fact that is the best mechanism that can truly determine if the target company would be “good” investment. The due diligence period is the time to carefully scrutinize the company in a holistically, not just the financials [4]. The period allows you to consider the crucial intricacies of the target company in order for the private equity firm to formulate concrete plans for the target company in order to obtain high returns on their investment, following the completion of the transaction. 

It is important to note that certain firms who choose to take a narrow approach to due diligence, and simply focus on the audit of the financial documentation alone, fail to consider the enormous and technical nature of private equity deals. It is crucial to confirm and verify all information during the deal or investment process. Private equity transactions are lengthy and tedious and as such necessitate the need to ensure that all transaction documentation are properly scrutinized. In addition, due diligence helps to identify potential defects in the deal or investment opportunity and thus avoid a poor business transaction. The quality and thoroughness of a viable due diligence can make or mar a deal. Both patent and latent defects can be adequately identified when due diligence is conducted on a Private Equity transaction. 

Furthermore, the valuation of a private equity deal is crucial to the success of the deal. Thus, the conduct of due diligence is essential to obtain information that would be useful in valuing the deal and ensure that the deal or investment opportunity complies with the investment or deal criteria. 

LEGAL DUE DILIGENCE 

Legal due diligence involves the process of collecting, understanding and assessing all the legal risks associated during a private equity transaction. During legal due diligence, the Investors or private equity firm or Limited Partner reviews all the documents pertaining to the Target Company/ Portfolio Company and sometimes interviews are performed on individuals associated with the specific company. The rationale behind this investigative procedure is to appreciate if there are any existing or future legal problems that may arise during the course of the acquisition [5]. 

Legal Due diligence is an integral and important feature of any private equity transactions. It is critical that investment firms or potential investors conduct a comprehensive legal due diligence to ensure that all potential risks and issues which may affect or shape the transaction are recognized and appropriately dealt with during the structuring and negotiation phase of the transaction. Legal due diligence in a financing transaction is undertaken by the lender(s), investor(s) or Firms to investigate the business, financial condition and creditworthiness of the target company and the terms of the underlying finance documents [6]. 

Legal due diligence focuses on examining such matters as the legality of the proposed transaction, verification of the title and value placed on assets, identification of risks that may reduce the value or use of those assets, and that there are no other liabilities that may adversely affect the target such as tax liabilities. Other things to look out for include litigation, restriction on the target’s company to conduct certain types of business and regulatory obstacles [7]. Solicitors need to identify any regulatory or third party consents that need to be obtained; legal restrictions on business operation or plans that must be complied with or modified; and existing obligations to employees that will arise from the transaction [8]. 

A thorough due diligence search would peruse the legal implications and regulations governing the transaction. The diligence undertaken by the lender(s) or Firm would seek to investigate if the target company validly exists under Nigerian Laws and regulations. This is essential as it would be a futile effort if at the end of the transaction it is realized that the Company is in fact not properly registered or duly incorporated under the governing laws in Nigeria, in this instant case the Companies and Allied Matters Act [9]. In addition, the legal due diligence would reveal if there are any approvals, permits or authorizations from Regulatory bodies before the transaction proceeds. 

It is vital to note that no specific regulation exists on the establishment, management and procedure of Private Equity in Nigeria. The laws or rules guiding each transaction would depend on the transaction and, more importantly, on whether the investment is in a public or private entity. It is therefore imperative that the Fund Manager or Solicitor is acquainted with the relevant applicable laws at each and every stage of any transaction. 

Accordingly, certain questions may arise in the course of the legal due diligence. For example, are there requisite corporate authorisations by the relevant authorities approving the transaction? Most corporate transactions require the authorisation of the specific regulatory agencies. For instance, the Securities and Exchange Commission’s introduction of discrete regulations for infrastructure fund investments in 2014, following the National Pension Commission (PENCOM)’s approval of infrastructure funds and private equity funds as asset classes for pension fund investments in 2010. However, the PenCom Regulations restrict such pension fund investment to infrastructure funds and private equity funds that are SEC-registered and run by SEC-licensed fund managers [10]. In addition, laws such as the Companies and Allied Matters Act [11] and the Partnership Law of Lagos State 2009 (as amended) would have to be re-examined [12]. A thorough due diligence should provide all necessary information and thus all private equity transaction require an efficient due diligence team. 

 

Read more on The Law & Practice of Private Equity on https://fabianajogwu.com/fb_books/the-law-practice-of-private-equity/.

Place an order for the book here.

 

RESOURCES 

  1. Anya Cummins, Partner, Head of M&A, ‘Private Equity Demystified: The fundamentals of private equity deal structuring’<https://www2.deloitte.com/content/dam/Deloitte/ie/Documents/Finance/Corporate%20Finance/IE_CF_PrivateEquity_0217_draft2.pdf> accessed December 19
  2. Fox & Fox, Corporate Mergers and Acquisitions, page 2B.02
  3. What is Due Diligence? <https://corporatefinanceinstitute.com/resources/knowledge/deals/due-diligence-overview/last> accessed December 19, 2018.
  4. Ibid.
  5. Definition of Legal Due Diligence < https://www.divestopedia.com/definition/6619/legal-due-diligence > last accessed January 16, 2019.
  6. Importance of Legal Due Diligence  <https://www.lawyard.ng/the-importance-of-legal-due-diligence-in-corporate-transactions>.
  7. See Professor Joseph E.O Abugu, Company Securities: Law and Practice (2nd Edition, MIJ Professional Publishers, 2014)
  8. Ibid
  9. Cap C20 LFN 2004
  10. Private equity in Nigeria: market and regulatory overview; <http://www.uubo.org/media/1362/private-equity-in-nigeria-market-and-regulatory-overview.pdf>
  11. Supra n7
  12. In 2009, Lagos State made certain amendments to its Partnership Law to allow individuals to carry on business as a Limited Partnership or as a Limited Liability Partnership in Lagos State 

 

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