When it comes to conducting due diligence in mergers and acquisitions, it’s all about looking for risks in a haystack of data, thanks in large part to the proliferation of documents and information to review for a proposed deal.
M&A lawyers say good due diligence is as important to a deal as the negotiation of the actual core agreement. That means the way due diligence work gets done has been undergoing an evolution in several ways as in-house clients seek to control costs, have better certainty on what they are bidding on and seek to achieve a more positive outcome in terms of post-merger integration. Technology, such as artificial intelligence, is one way due diligence review is getting done faster and smarter.
“The technology allows you to do your job better,” says Anne Glover, practice group leader of Blake Cassels & Graydon LLP’s InSource Team in Toronto. “It doesn’t take away the fact that humans still need to look at it, but it allows you to be smarter and use your judgment.”
“People are realizing there are a lot more documents and I think a lot of people have not yet changed the way they do due diligence,” she says. “So there is obviously a conflict because deals are time sensitive and if you’re still doing it the old way you’re never going to get through it. The whole goal of due diligence is to find out what your risks are; it’s not to find all the stuff you don’t care about.”
At Blakes, the InSource team’s job is to find the risks, and if they can find them using AI, it means they can raise the issue with clients sooner.
“They can go to the other side to deal with anything that is an issue,” she says. “The volume of the documents is so big. If you don’t have AI, there is only so much you can review, and the risk of missing something important goes higher and higher.”
With serial acquirers, there is a trend of companies relying less on traditional firms and moving it in-house with a complement of external contract and traditional law firm support, says Bryan Friedman, general manager of Axiom in Canada, which provides technology-enabled legal and contracting services.
If a deal needs an employment law or competition law focus, traditional firms will do a brief first cut, but in-house deal teams are leveraging different external providers to supplement their in-house staff, says Friedman.
Technology, and specifically AI, is playing a large role in how due diligence review is being conducted, compared to five years ago.
“We’re seeing a push on both the acquisition and divestiture side for the serial players to do that because the traditional soup-to-nuts law firm model starts to make less and less sense when these things can get into a rote transactional nature,” he says.
Companies are also starting to use their own contract management tools to try and understand the situation — especially if they are selling contracts — to better understand what they are selling and, therefore, spending less time reviewing contracts.
“On larger transactions, I think you’re seeing a big push to disaggregation, which is about relying on a mix of external providers to leverage against different deal components — part of which leverages tech in order to extract, analyze and get value from contract data that wasn’t possible before,” says Friedman.
Traditional law firms are still running point on the primary deal documents and negotiations such as sales and purchase agreements, asset purchase agreements and major representations and warranties and indemnity provisions, but more and more diligence around the deal is either being done in-house or farmed out to external providers who are leveraging more sophisticated contract review technology and processes to extract the data.
“I think a lot of that is driven by recognition that a lot of deals don’t achieve their synergy targets,” says Friedman. “What we’re seeing is deal teams trying to get better at analyzing the contract data they are acquiring prior to close but also deploying the value of that data or the information from that data to make the integration process that much more seamless.”
There is also more sharing of that information across business teams.
New providers and tools are allowing bidders to do their own diligence much more quickly. In an auction environment where a seller is putting up a piece of business and wants to acquire as many bidders as possible, the diligence phase often becomes a time suck.
“As the saying goes, time kills all deals, so deal teams are starting to say, ‘Hey, we can give you a quicker and more sophisticated overview so you can finish your review in a fraction of the time’,” says Friedman.
“If you can create one database that has all the pertinent information and then create reports or analytics around that information, it’s much more digestible and you can then distribute the information across your business units and they can see at a glance the provisions they need to deal with or opportunity embedded within them — that’s allowing businesses to get smarter and better on the integration phase.”
There is also more attention being paid to the contracts being acquired, and the combination of processes and technology are allowing that to happen more quickly. That is also making things more cost effective.
“Historically, you couldn’t reasonably expect to analyze 10,000 to 15,000 contracts in advance of a deal. Now that dynamic is starting to change,” says Friedman.
And that’s a good thing since clients want more information about what they are buying and there is the desire to expedite the sale process and to make sure the integration experience is better for the business.
Blakes and many other large firms now use tools such as Kira to run documents through, and although the software isn’t always 100-per-cent right, it can flag things you wouldn’t have had a chance to look at doing it the old way.
“I had an example of client who said they had a deal and at the last minute thousands of documents came through and they had to say they’d take the risk because there wasn’t the time to look at it all, but if they had the tools being used now they would have put the documents in even at the last hour at least to see if the technology could say there was an issue rather than saying ‘we don’t know what’s in the documents,’” says Glover.
The approach many now take is using a combination of people and technology to reduce risk.
“That’s how we’ve been using artificial intelligence with respect to contract review in due diligence. It’s a combination of the people and the technology and the technology helps get you there. I honestly don’t know how we would be able to do it without it,” she says. “The computer will pick up things human eyes would glaze over.”
In a test pilot, Blakes found it was 50-per-cent faster in the process without having really used the program before. The firm is saving even more time now because the lawyers are trained on it. “Like anything you get better at it as you use it, so you start to find the tricks of the software and how to be more efficient, which means half the hours in cost,” says Glover.
Of course, a key step in the due diligence process is to discuss how the work should be approached, says Chris Fowles, managing partner of Torys LLP’s Halifax office, established in 2014 as the firm’s Legal Services Centre. There are 12 lawyers and three paralegals doing work such as due diligence.
“Due diligence is one of those things that differs by client and file and, unlike ongoing work, every transaction is a little bit different, but a good starting point is a discussion with the client around ‘What is important to you as we look through these files? Do you want us to look at everything?’ This is a risk assessment on their part — do we look at the top 50 supplier contracts or top 50 client contracts?” says Fowles.
The assumption in the past, says Fowles, is that if the client wasn’t asked that question and the external firm was given access to the data room, then the client would want everything reviewed.
“That’s not necessarily the smartest way of doing it and not necessarily what the client wants,” he says. “That upfront discussion about the client and their objectives is really important. Having that context to bring to the reviewing team helps a lot as well in terms of where people put their effort and what they think about as they are going through the review.”
Fowles says what AI does not do is bring judgment and context to the review process; however, it’s very good at pointing out things for his team to look at based on what they tell it they are interested in.
Another thing that has become a bigger focus is the management of the project and communications in terms of keeping people up to speed on the progress of the work.
“The classic example is if you’re not sure if it’s going to be an asset transaction or a share transaction and whether that means you’re looking at change of control or assignment clauses,” says Fowles.
“There is also a project management aspect to it where you are assigning things for people to look at and you can track progress. If someone has gotten busy on something else, you can reassign other things to avoid bottlenecks and allocate work to other people.”
Naturally, clients are also more focused on the cost of the due diligence process. Fowles says they ask for fixed fees or estimates.
“They want to know when circumstances have changed that might change the fees and sometimes they want weekly reporting on where things are in terms of hours and time spent,” he says.
“Clients are quite focused on how much it’s going to cost just to do the due diligence, never mind the transaction,” says Fowles. “They may not end up being the preferred bidder and so it’s valuable to know what they’re getting. How much will it cost me to get to the next stage?”