Many businesses grow and earn profits from year to year, but still face existential threats if legal problems happen. Others have owners who have reached a point in their lives where they want to exit their business to start a new chapter in their lives. In both of these situations, business owners can benefit from legal audits. They lay the foundation for both the avoidance of legal disasters and the identification of unappreciated legal issues that can restrain the value of a business in the context of its sale. A legal audit identifies the issues that a business needs to address from a compliance and prevention perspective to match the company’s goals, structure, and ongoing operations to the current legal environment.
1. What Is a Legal Audit?
The audit typically involves legal counsel examining records, procedures, and policies and discussing legal issues with the business’s managers. The inquiries of the audit generally include:
-organizational documents (articles of incorporation or articles of organization, operating agreements, buy-sell agreements, and documentation of shareholders’ and members’ meetings, equity ownership records),
-government filings (tax identification numbers, local and state licenses, and qualification to do business in specific states),
-insurance (property damage, liability, products liability, vehicle, business interruption, director and officer’s liability, workers’ compensation, health and medical, key person life insurance, and employment practices liability),
-business contracts (purchase orders, invoices, credit applications, service contracts, and vendor contracts),
-employment relations (recruiting and hiring practices, I-9 Forms, employee handbook, independent contractor/employee classifications, exempt and non-exempt status for overtime, policies regarding unlawful harassment, reasonable accommodation, at will employment, bonus plans, employee benefits, equal employment opportunity, background checks, occupational safety and health, and drug testing),
-intellectual property (patents, trademarks, service marks, and copyrights),
-real estate (leases), and
-pending and threatened litigation.
After legal counsel gathers the information necessary to complete the audit, she or he compiles a legal status report. It summarizes the data collected, whether any aspects of it poses legal risks for the business to manage, alternatives regarding the management of such risks, and counsel’s recommendations for action.
2. How Do the Results of Legal Audits Help Business Owners?
The legal audit’s results give a business a roadmap for managing legal risks that left unaddressed may lead to litigation or could decrease the business’ value if its owners want to sell the business. In the context of litigation avoidance, the implementation of corrective actions to implement the audit’s recommendations can prevent the following types of claims:
-litigation by third parties, or even co-owners, to ignore the limited liability that corporations offer to shareholders and limited liability companies provide to their members because of the business’ failure to keep proper books and records or the mixing of business assets with personal assets;
-government enforcement actions because of the business’ failure to obtain all proper permits and licenses, which could cause the imposition of fines, penalties, or even closures of the business;
-lawsuits or administrative actions that impose damages awards and fines because of the business’ failure to obey tax, equal employment opportunity, wage and hour, occupational safety and health, immigration, or securities’ laws;
-lawsuits and damages awards because of the directors’ failure to keep accurate records and minutes of their decision-making procedures in actions brought by shareholders and investors against the business and its board of directors; and
-default actions in which lenders or investors bring claims against the company because of its failure to monitor the company’s reporting requirements in loan documents or leases.
The early detection of problems can save the business time, effort, and money. It might even make the difference between a thriving and a failing business.
3. What Difference Can the Implementation of a Legal Audit’s Recommendations Make in the Sale of a Business?
In the context of owners getting ready to sell their business, a legal audit provides many other benefits if they take action on the audit’s recommendations:
-avoiding unwanted surprises during the buyer’s due diligence by identifying problems before the buyer does;
-having sufficient time to fix or to mitigate the problems before offering the business for sale;
-maximizing the business’ value or, at least, avoiding the negotiation of a price reduction in response to the results of the buyer’s due diligence;
-eliminating any regulatory compliance issues before any due diligence takes place;
-preparing and organizing due diligence materials for the sale process; and
-enhancing the credibility and bargaining power of the business’ seller.
The cost of a legal audit varies in accordance with a business’ complexity and the number of issues that the audit addresses. Typically, Evans & Dixon performs legal audits on a fixed fee basis. If you would like to know more about a legal audit for your business, please contact Gerry Richardson at (314) 552-4053 or grichardson@evans-dixon.com.
