Module 1
What due diligence is: purpose, scope, deal types and the data room
Before a company is bought, a business is invested in or a large contract is signed, the person paying wants to know what they are getting. Due diligence is the investigation that answers that question. A buyer’s lawyers, accountants and other advisers ask the seller for documents and information, read what they receive, find the problems and report to the client in a form that lets it decide: go ahead, change the price, ask for protection or walk away. The work is often done under pressure, in weeks, on thousands of documents held in an online ‘data room’, and it is a rich field for lawyers who can work with data: the limiting factor is almost never the law, but how to read a mountain of documents sensibly, find what matters and say it clearly. This course teaches that skill with the methods of a data-minded lawyer: requests that can be tracked, sampling that tells you how much you can safely leave unread, scans that order your reading, findings that can be ranked and turned into protection, and honest statements of what was and was not checked. This first module explains what due diligence is for, the areas it covers, how the type of deal changes it, how to set the scope, who does what and what a client can rely on. It is jurisdiction-neutral and every company, person and deal is invented.
Hover over an idea to light up what it connects to, click it for its definition, minimum requirements, an example and the usual trap, press Play to watch the map build step by step, or trace a short case through it.
Simplified teaching map, in general terms. Check the law where you work. On a small screen, scroll the map sideways.
By the end of this module you can
- Explain what due diligence is for.
- Name the areas of review.
- Distinguish share, asset and investment deals.
- Set a scope and materiality threshold.
- Describe the roles, reliance and the data room.
Part 1. The lecture
What due diligence is for
The buyer of a business is in the position of a person buying a used car with no right to a test drive: the seller knows far more than the buyer. Due diligence reduces that gap. It has four purposes, and a good review serves all of them.
| Purpose | The question | Example (invented) |
|---|---|---|
| Find out what you are buying | Is the target what the seller says it is? Does it own what it claims to own? | The seller says it owns a brand; the register shows that a former director holds the trade mark. |
| Find problems and their price | What could go wrong, how likely is it, and what would it cost? | A major customer can cancel when the company is sold. |
| Decide and negotiate | Should we proceed, and on what terms: price, conditions, protection? | An unpaid-wages liability is taken off the price. |
| Plan the next stage | What must be fixed before closing, and what must be done in the first hundred days? | A key licence must be transferred, or renewed, before completion. |
Due diligence is also a record. If the deal later goes wrong, the buyer’s advisers will be asked what they found, what they told the client and what they did not check. A good report states plainly what was reviewed, what was not and what assumptions were made.
What it is not
It is not an audit, and it does not prove that a business is sound. It is a risk-based review of the information the seller provides, within a time limit, for a particular client and deal. What was not disclosed, or was not asked for, is not covered.
The areas of review
| Area | What is checked | Typical red flags |
|---|---|---|
| Corporate | Constitution, ownership and share history, group structure, approvals | Unclear title to shares; undocumented side deals with shareholders. |
| Financial | Accounts, debt, guarantees, off-balance-sheet liabilities | Loans with a change-of-control repayment; guarantees to related parties. |
| Commercial contracts | Main customer, supplier and distribution contracts | Termination on change of control; exclusivity; uncapped liability. |
| Employment | Key staff, pay, pensions, collective agreements, disputes | Underfunded pension scheme; unpaid holiday pay; misclassified contractors. |
| Intellectual property | Ownership, licences, infringement | Software written by contractors with no assignment; open source licence conflicts. |
| Real property | Title, leases, planning | A lease that ends soon; no consent to assign. |
| Litigation and disputes | Claims in progress or threatened, settlements | A claim that is not provided for in the accounts. |
| Regulatory and compliance | Licences, permits, bribery, sanctions, competition law | A licence that lapses on a sale; an unresolved investigation. |
| Tax | Returns, disputes, structure | Unpaid payroll taxes; aggressive structures. |
| Data protection and IT | Personal data, breaches, systems, cyber-security | An unreported data breach; no basis for processing a customer list. |
| Insurance, environment, health and safety | Cover, claims, permits, incidents | Contamination; cover that excludes the main risk. |
Different advisers cover different areas. Lawyers usually take corporate, contracts, employment, intellectual property, property, litigation, regulatory and data protection; accountants take financial and tax; specialists take technical, environmental and commercial issues. The data-minded lawyer’s job is to make the legal part systematic, so that what was asked, what was received, what was read and what was found can be shown.
How the type of deal changes the work
| Deal | What the buyer gets | What it means for diligence |
|---|---|---|
| Purchase of shares | The company itself, with all its assets and all its liabilities, known and unknown | Wide review: past liabilities come with the company. Check the shares, the history of the company, tax, claims and everything else. |
| Purchase of assets (a business) | Chosen assets and liabilities, usually not the history | Narrower on past liabilities but intense on title to each asset, the transfer of contracts (consent) and the staff who transfer. |
| Minority investment | A stake with rights, not control | Focus on the investor’s rights: governance, reserved matters, exit, dilution, information, and the health of the business. |
| Merger or joint venture | A combined business, or a shared one | Both sides review each other. Competition law and information exchange need care. |
- In a share deal the buyer inherits the past. A tax assessment, a pollution claim or a breach of the law from five years ago becomes the buyer’s problem. This is why diligence is wide and why indemnities and warranties matter.
- In an asset deal the buyer inherits less but must move each piece. A contract that cannot be assigned without consent, a licence tied to the seller, or staff who must be transferred under employment law each needs checking. See Module 4.
- Whatever the structure, price and protection are linked. The more the buyer can learn, the less it needs to rely on the seller’s promises, and the other way round.
Scope, materiality and depth
No review covers everything. The scope is a decision, made with the client at the start and written down.
- What is the deal, and what matters to the client? A buyer paying for a customer list cares about customer contracts; a buyer paying for a factory cares about the licence and the land.
- Set a materiality threshold. For example, report any contract above a revenue figure, any claim above a sum, any issue that could affect price or closing. Without a threshold, the report drowns in detail. With one, you must say what it is.
- Choose the depth. A red-flag review looks only for the issues that could stop the deal or change its price; it is fast and cheap and is typical at an early stage or on a short timetable. A full (confirmatory) review reads more broadly and in depth and supports the warranties and the final price.
- Fix the timetable and the team, and agree how the report will be delivered and to whom.
Write down what is excluded
Every scope should state what the review will not cover: areas left to other advisers, documents that the seller will not provide, jurisdictions where local counsel was not engaged, issues below the threshold. Clients who later say ‘you did not tell us’ must be able to see that they were told what was not checked.
Roles, reliance and the data room
| Who | What they do |
|---|---|
| The buyer (and its principals) | Decides whether to proceed, and on what terms. Owns the commercial judgement. |
| The buyer’s lawyers | Prepare the request list, review documents, report findings and advise on how to deal with them in the contract. |
| Other advisers | Accountants (financial, tax), technical and environmental consultants, insurers. |
| The seller and its advisers | Assemble the data room, answer questions and negotiate how findings are handled. |
| The target’s management | Answer questions in management meetings; their statements need to be checked against documents. |
- Reliance. Diligence reports are written for the client. Others (such as lenders or insurers) may ask to rely on the report, and the adviser must decide on what terms, since the duty it owes would then widen. Many reports say that no one else may rely on them.
- The data room is a secure online repository where the seller places the documents. Modern virtual data rooms provide indexing, access permissions, a question-and-answer log, watermarks and an audit trail of who opened what. Part 2 covers how to use them.
- The limits of what you can know. The data room holds what the seller has chosen to put there. A thorough review of an incomplete room is an incomplete review, so the report must say so.
- The deal moves. Findings change the price and the contract terms, so the diligence team and the deal team must work together, daily.
Part 2. Lab: What Is It For?
Choose the best answer in each situation.
Situation 1 of 3
A client asks, ‘Does the due diligence report mean that the company is sound?’
What is the best answer?
Part 3. Lab: Share or Asset?
Sort each point by the type of deal where it matters most.
Situation 1 of 6
“The buyer inherits a tax assessment from three years ago.”
Where does this belong?
Part 4. Lab: Spot the Scope Mistake
Click the lines that a scope statement should not contain.
Draft lines for a scope statement
Click every sentence that causes a problem, then press Check. There may be 3 problems, and some sentences are fine.
Part 5. Check your understanding
Ten questions drawn from a larger pool. Sign in to have your score saved towards your certificate.
You have finished the free module
Here is what you can do now, and where the course goes next
Module 1 gave you
- Explain what due diligence is for.
- Name the areas of review.
- Distinguish share, asset and investment deals.
- Set a scope and materiality threshold.
- Describe the roles, reliance and the data room.
Next, 6 more modules and a capstone
- Module 2: Requests and the data room: the request list, the index, tracking and the question logYou will learn to build a request list that fits the deal.
- Module 3: Sampling and coverage: what you can safely leave unreadYou will learn to explain why and when to sample.
- Module 4: Reading the contracts: the clauses that move in a dealYou will learn to name the ten clauses that move in a deal.
- Module 5: Red flags and findings: turning what you read into what the client can useYou will learn to rank findings by severity and likelihood.
- Module 6: From findings to deal protection: price, conditions, indemnities and warranties
- Module 7: Privacy, ethics and AI in review: running a room responsibly
- Capstone: Capstone: the Marlow & Pryce data room
Each module has its own practice labs and a graded quiz, and a Certificate of Completion follows when you pass them all. The whole course is $15 once, or included in an All-Access Membership.
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General education on legal due diligence, using invented companies, contracts, people and figures. It states common practice in simplified form and does not describe any one country's law, which differs and changes; rules on disclosure, the effect of a buyer's knowledge, privilege, data protection, competition law and liability in particular vary. It is not legal advice, and it does not replace advice from a qualified lawyer on a real transaction.
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