Seller-Side Preparation for Legal Due Diligence: Building a Contract Register and Keeping Records in Ordinary Times

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

In M&A and due diligence, broad areas of a company, such as contracts, shareholder relations, and labor management, are examined intensively over a short period. What buyers and investors look at in that process is not limited to whether the documents are in order. In addition to the nature of the risks the company carries, they assess whether the company accurately understands those risks and is in a position to explain them logically as the history of its management decisions. Keeping records of contracts and decisions as a matter of course is preparation for an acquisition review.

Strength here does not mean that there are no legal issues whatsoever. A fast-growing company will have had occasions when it made do with simple documents in a rush to close a deal, when it accepted terms that departed from its standard contract terms, or when its documents from the founding period were not fully in order. What matters is that management understands the company's condition and has decided which risks to accept, which deficiencies to correct in advance, and how to explain matters to the other side.

Companies around a Series A may not have the room to expand their administrative function by hiring dedicated legal staff as a fixed cost. At the stage of looking ahead to a future M&A or the next round, the company can also consider using outside attorneys much like in-house legal team members to review contracts and shareholder relations in ordinary times. The handling of intellectual property and personal information should also be checked on an ongoing basis.

Materials and Records to Check First

Before getting into individual issues, please check the following five points as a guide to understanding where your company's legal management currently stands.

• Where contracts are stored, and a cross-cutting understanding of termination conditions and change of control clauses
• Records of the reasons for accepting contract terms that depart from the standard
• Consistency among the shareholder register, minutes, and documents relating to stock acquisition rights
• Confirmation of rights ownership and licenses with outsourcing contractors and joint development partners
• Progress in starting a light inventory, beginning with key areas

Contract Management and Recording Exceptions

As a business grows, the number of contracts it concludes, such as service agreements, terms of service, and distributor agreements, increases rapidly. If storage locations and management methods are fragmented by person in charge, even checking the content of past contracts takes a great deal of effort.

In due diligence, the buyer checks which contracts are still in effect, what the conditions for termination and automatic renewal are, and whether contracts with key customers contain transfer restrictions or change of control clauses (provisions on consent, notice, termination, and so on upon a transfer of control or similar). Creating a contract register is not merely formal administrative management; it is the foundational material for explaining the continuity of the business to the buyer.

In addition, in practice at growing companies, there are occasions when the company has no choice but to accept terms that depart from its standard templates, or when it lets an urgent transaction go ahead first. Such business decisions are not in themselves immediately called into question. What tends to become a problem is a case where the background to the decision, such as why the exceptional terms were accepted, who approved them, and what risks were factored in when concluding the contract, has not been kept within the company.

Exceptional payment terms, contracts with no limitation of liability, and special arrangements on the ownership of intellectual property are items that attract particular attention in an acquisition review. Legal also has the role of preserving within the company the reasons for management decisions.

What Buyers Focus On and the Consistency of Internal Documents

In due diligence, the buyer's attorneys raise many questions. Due diligence is not a procedure that guarantees there are no problems; it is an investigation to identify potential risks. The buyer considers how much any deficiencies found would affect the continuity of the business, whether they should be reflected in the purchase price, whether to require correction before closing, and whether to address them through representations and warranties clauses or the like.

For this reason, there are situations where, as the seller, factual answers alone, such as "we have the contract" or "we do not have the minutes," are not sufficient. If you can explain the background, whether there was any actual harm, and the possibility of correction through negotiation with the counterparty, this becomes material the other side can use in considering the terms.

Particularly for companies preparing for an M&A or a stock listing, the consistency of the shareholder register, the minutes of shareholders' meetings, and what is stated in the investment agreements is strictly scrutinized. If oral agreements from the founding period, share relationships with founding members who have left, and agreements among shareholders at past capital increases are left ambiguous, a great deal of time will be spent on later confirmation and on adjusting interests. Because the necessary corporate approvals and records are judged according to the nature of the company and the transaction, carry out resolution procedures suited to your company's situation at the necessary times.

Furthermore, in companies whose product or service value relies on intellectual property, the buyer strictly checks whether copyrights and invention rights have vested in the company, or whether the company has obtained the licenses necessary to carry out its business, with respect to development contractors, external side-job members, and employees. It is important to check the rights relating to source code, designs, and accumulated data without omission as part of the ordinary work of concluding contracts.

Taking Inventory in Stages and Preparing a Data Room

If you rush to start checking documents only after notice of an acquisition review arrives, missing contracts, unprepared minutes, inconsistencies in stock option documents, and the like all surface at once, and you will be swamped dealing with them. Even if each deficiency can be resolved, having them concentrated in a short period can put pressure on normal business operations.

Therefore, check key contracts and the shareholder structure before any concrete deal comes up. It is also effective to carry out a low-burden inventory of priority items in labor management. The aim is to understand early on the issues remaining in your company and the order in which to address them. Simply starting to check important materials, such as contracts with key customers, shareholder-related documents, the list of stock options, and the work rules, will make clear where the issues to be improved lie.

In practice, setting up a simple data room (shared folder) in ordinary times leads to a faster initial response. For example, create folders for basic company materials and shareholder relations, and store materials on key contracts and on licenses and regulatory compliance separately. Add categories needed for the business, such as intellectual property and labor.

For key contracts, check the contract term, the notice period for termination, and whether there are transfer restrictions. For intellectual property, check whether the company holds the necessary rights or licenses with respect to founders, employees, and outsourcing contractors. In the labor area, organize employment contracts, the work rules, the status of overtime management, and whether there have been past disputes with departed employees. For example, if a contract with a key customer contains a change of control clause, make a comprehensive judgment as to whether the counterparty's consent is required before executing the M&A, at what stage to approach them, and how much impact there would be on the continuity of the business in light of revenue dependence and the balance of power with the counterparty. Such judgments require consideration grounded in reality, not merely a formal reading of the provisions.

An Outside Legal Structure in Ordinary Times and Our Contact Point

In preparing for due diligence, the number of materials to be checked is enormous. Trying to read all the documents from the start by manual work alone would take excessive time and cost.

AI can be used to help with the initial review work. We use it for initial tasks such as categorizing contracts by type, extracting change of control clauses, detecting candidates for missing stored materials, and preparing first drafts of anticipated question lists and answers. However, the issues AI picks up cannot simply be adopted as the company's final view. Which risks bear directly on the negotiation of the purchase price, which risks can be accepted with an oral explanation, and which business partners should be approached in advance for an amendment agreement require the judgment of attorneys who have assessed the reality of the business and the negotiating situation.

At LegalAgent, we go beyond one-off contract reviews to support building a legal structure that can withstand scrutiny, through reviewing contract provisions, designing contract registers, organizing investment agreements and shareholder relations, conducting advance checks with an acquisition review in view, and providing ongoing support for in-house legal work.

Even at a stage before appointing dedicated legal staff, using outside attorneys on an ongoing basis allows you to strengthen the legal function as a variable cost in line with the workload. Properly recording the background of contract decisions and shareholder relations in ordinary times is preparation for explaining that background to buyers and investors in a future M&A or the next round.

If you are concerned about whether your current contract management structure can cope with a future acquisition review, or you cannot decide where to start ahead of a financing, please contact us through the following page.

• M&A Support

Frequently asked questions

Why is a contract register given weight in legal due diligence?

Because it is the foundation for explaining the continuity of the business to the buyer. In an acquisition review, the scope of valid contracts, termination conditions, and whether contracts with major business partners contain transfer restrictions or change of control clauses are examined intensively. In practice, it is considered appropriate to centralize where contracts are stored and also to record the reasons for accepting terms that depart from the standard and the approval process.

How should we deal with contract terms that differ from the standard template?

You need to keep internal records of the reasons for accepting the exceptional terms, the person with approval authority, and the background of the risks accepted. This is because an acquisition review examines not only the terms themselves but also the background of the management decisions. In practice, preparing to explain the background, whether any actual harm has occurred, and the possibility of correcting the terms through negotiation with the counterparty is considered effective in resolving the buyer's concerns.

What preparations can we make in ordinary times so that we do not scramble right before an acquisition review?

It is effective to take inventory of important documents and set up a simple data room in ordinary times. If you start only after being notified of the review, dealing with missing or never-prepared documents becomes concentrated in a short period and puts pressure on ordinary operations. In practice, it is considered desirable to store basic corporate documents, the shareholder register, major contracts, labor management documents and the like in separate categories, and to understand your company's issues and the order in which to address them in advance.