The introduction of virtual data rooms some 10 years ago has had a major effect on shortening deal cycles, increasing valuations, and increasing productivity. They replaced labour-intensive, paper-based due diligence where lawyers, accountants, and executives flew across the globe to complete mergers and acquisitions and loan syndications. Undoubtedly, a lot of trees have also been saved.
Checklists for populating VDRs with content are readily available either in your existing treasure chest of precedents, online, or through your external counsel or financial advisers. They should at a minimum include information relating to financial matters, material contracts, corporate information, product information, intellectual property protection, human resources, litigation, insurance, environmental compliance, customer and marketing information, information systems, and internal controls.
Often in-house counsel is tasked with creating the framework for a VDR (i.e. headings and electronic file folders) as well as establishing specific guidelines as to what exactly should be downloaded into the room. Unless adequate forethought is used, however, many of the advantages that can be achieved by having a VDR ready to go ahead of a transaction can be readily lost.
Don’t reinvent the wheel
There are numerous software companies that offer data room solutions with a comprehensive set of bells and whistles. For example, you may want to populate the entire room but close off access to detailed files for the purposes of early due diligence. Sensitive human resources information can be made available only to a select small number of parties on the due diligence team.
Most VDRs have the ability to protect certain files on a read-only basis. As due diligence teams travel through a data room interesting insights can be gleaned in terms of who has reviewed particular documents, and potentially reveal their level of concern with regard to a particular area or issue.
As additional information is added to or removed from the room, e-mail notifications can be pushed out to the due diligence team resulting in greater efficiency for the parties involved. Many permit the due diligence team to ask questions and the seller’s team to post answers around the clock, often through a mobile app.
Trying to save a few dollars by creating an FTP site or other home-grown solution is not only inefficient and potentially more costly, but also likely to significantly limit your deal universe. Take advantage of existing solutions on the market, become intimately familiar with their features and functionality, and learn how to use them strategically to your advantage.
Dovetailing to transactional documents
Purchase-and-sale agreement templates used by in-house counsel contain representations and warranties tied to disclosure schedules. It makes sense to review the templates and dovetail the information in the VDR to the disclosure schedules. I have been involved in a few transactions where the draft sale agreement and the VDR were not in sync. It was relatively easy to negotiate the representations and warranties and corresponding disclosures in my client’s favour so they matched where it was to my client’s advantage.
Be forthcoming
All other things being equal, it is usually best to disclose more rather than less. In transactions involving the sale of a business, for example, the purchaser assumes the liabilities and risks described in the disclosure schedules. The purchaser has recourse against the vendor only for misrepresentations, or fraud, or matters that were required to be disclosed but were not listed in the disclosure schedules.
This being the case when constructing a VDR, it is often best to disclose more rather than disclose less.
Controlled access
Part of the deal-making process involves pre-planning to identify the documents to be released to buyers and the sequence of their release. Which party or parties will have access and when information will be disclosed to them is often a reflection of who is in the universe of buyers, whether the sale is to be competitive, whether there is a lead or preferred buyer, and whether the interested parties are competitors as well as other similar factors.
Parties might be provided with a teaser before being allowed broader access to the VDR. Often deals will have milestones after which certain prospective buyers drop off, and others are allowed to continue deeper into the due diligence room.
Most VDRs on the market allow this kind of controlled access. It is critical in-house counsel be aware of the deal structure and due diligence process. Allowing unfettered access to one or more potential buyers can cripple a deal if a party decides to walk during the due diligence phase, particularly if the shopper was a direct competitor (likely leading to the proverbial “haircut”).
Importance of monitoring
Best-of-breed virtual data rooms allow administrators to drag and drop files into the VDR, change participants, and update read and print access. As more interested parties are added to the process, even with best-of-class software, it can potentially become chaotic. It is important to monitor activity in the VDR and ensure at all times the appropriate permissions and blocks have been maintained. Deals can potentially be sunk or be dealt a serious body blow if there is an unauthorized leak of information.
First mover advantage
Having a well-thought-out, logical, organized VDR not only creates a strong positive first impression and bond of trust, it may also provide the vendor with a first-mover advantage in regard to shaping the terms of the deal. A prospective purchaser of a target company that is ill prepared is likely to try and drive the deal by tabling an extensive due diligence list. This is much less likely to happen in my opinion if the vendor has a pre-existing, well organized data room.
Due diligence objectives
VDRs are not only used to verify the enterprise value of the target company, help structure the deal, and determine the allocation of risks and liabilities, they are also useful in identifying potential synergies and providing a post-closing roadmap.
Information posted in the VDR will help drive decisions such as employee layoffs, which IT systems to adopt and abandon, which locations should be shuttered, and other post-deal improvements. It is important to bear this in mind when constructing the VDR and ensure information of interest to the buyer in creating a post-closing plan is clearly available.
Customization
Each deal has its own “beat.” It is often useful to perform reverse due diligence on a potential buyer before granting them access to the VDR. Has the purchaser had any recent negative experiences such as a deal gone sour, class action litigation resulting in a large award, a patent infringement suit, etc.?
I have sometimes found it useful to identify a purchaser’s pressure points and have purposely beefed up disclosure in that particular area to assuage any concerns it may have.
Summary
Putting together a due diligence list should not be mechanical. It should not occur in a vacuum. VDRs should be populated based on standardized agreement templates. There should also be pre-planning discussions regarding potential purchasers and deal structure, mindful that more is usually better, VDRs are often used to structure the acquisition to be accretive and create a post-closing integration plan, and the prospective purchaser may have baggage you may be able to offset by beefing up disclosure in particular areas.
